In the weekend commentary, I spoke about the lack of a catalyst to power the market out of its dormant phase. Who knew the Treasury Dept would provide that event.

Market Statistics

In case you have not heard, the Treasury Department took specific aim at a "serial inverter" and said it was implementing rules to prevent these types of transactions. An inversion is when a U.S. company buys a foreign company and then announces it will move its corporate headquarters to that other country while much of its operations remain in the USA. Typically, the other country has a much lower tax rate.

The target of the new rules was the $160 billion Pfizer (PFE) acquisition of Allergan (AGN). One of the new rules requires the overseas company to be of a certain size relative to the U.S. company. Allergan has been a serial acquirer. Actavis bought Warner Chilcott in 2013 for $5 billion. In 2014 Actavis bought Forest Labs for $25 billion. In 2015 Actavis bought Allergan for $66 billion and then changed the name of the company to Allergan. That combination of moves lifted Allergan's market cap to roughly $120 billion. Pfizers CEO has been working for several years to find a merger partner overseas that would qualify under the inversion strategy because Pfizer pays billions in taxes every year since the U.S. has the highest tax rate of any industrialized country. After Allergan bulked up to qualify for a deal, Pfizer and Allergan announced their merger. They specifically crafted the merger to fit under the inversion rules in effect at the time.

A new Treasury Dept rule they announced on Monday requires a three year look back provision to prevent this "bulking up" to qualify for an inversion. That means Allergan cannot count the market cap they gained in the Forest Labs or Allergan acquisitions in qualifying for an inversion until the three-year window expires at the end of 2018.

I am all for passing laws that make it advantageous to keep companies in the U.S. and paying taxes. However, I am against passing laws that target specific companies in order to prevent that company from moving. If you want to keep companies in the U.S., it needs to be a restructuring of the tax rate for everyone rather than using the power of the government to attack an individual company. This is what soured the market. Investors do not like government interference, especially targeted attacks.

Reportedly Pfizer and Allergan are about to announce the cancellation of their merger. There is a $400 million breakup fee to be paid by the party that terminates the transaction but given the circumstances that could be modified.

Hedge funds were big holders of Allergan shares and they had a bad day. Viking, Elliott, Third Point, Blue Ridge Capital and Paulson & Co were all big holders.

Allergan shares fell -15% on the news to $235 and Pfizer shares rallied +2.5%.

Dow component Disney (DIS) was also impacting the Dow with a -2% decline after COO Tom Staggs, the heir apparent to CEO Bob Iger, said he was leaving the company in May. Iger was planning on leaving in 2018 and now analysts believe he will stay until 2020 to give the board time to groom a new succession candidate. Staggs had been the assumed replacement for several years. For the board to suddenly dump Staggs caused a wave of confusion among analysts and sharp drop in Disney shares.

Ford Motors (F) also created a cloud over the market with news they were going to build a $1.6 billion manufacturing plant in Mexico. Normally this could not be a big deal since the passage of NAFTA has seen dozens if not hundreds of companies move operations to Mexico where wages are closer to $2.50 an hour instead of $25 an hour in the U.S. manufacturing sector. However, in the current political climate the announcement was a lightning rod for candidates and Trump wasted no time warning this would not happen if he were president. Analysts immediately wondered if the current administration would suddenly change the laws to target Ford's plan like they did with the Pfizer/Allergan plan.

To be fair, Ford is not moving a plant to Mexico. They are building a completely new plant to produce small cars that can be exported all over the world. Cars produced in the U.S. cannot be exported to a lot of companies because of trade laws. For instance, U.S. cars cannot be exported to Brazil and that is a rapidly expanding market. Mexico has more favorable export laws and trade agreements than the USA and cars can be exported from Mexico to most other countries.

Those facts did not ease the worry over the potential for new regulations in the current environment. Mexico had refrained from announcing or discussing the new plant in order to avoid being in the campaign spotlight. News leaked out and Ford finally announced the plans.

On the economic front, our friends overseas were not helping. IMF's managing director, Christine Lagarde, warned this morning that "the global recovery was too slow, too fragile and the risks to its durability are increasing." While she did not say anything new, the comments acted to depress the European markets and that depression carried over into the U.S. markets. The IMF cut its global growth outlook for 2016 to 3.4% in January and her comments today suggest there is another downgrade ahead. She warned "the global outlook has weakened further over the last six months, exacerbated by the slowdown in China, lower commodity prices and the prospect of financial tightening for many countries." "In the euro area low investment, high unemployment and weak balance sheets weigh on growth. In Japan, both growth and inflation are weaker than expected." Longstanding "crisis legacies" including high debt, low inflation, low investment, low productivity, and, for some, high unemployment, posed a risk for advanced economies. Emerging economies meanwhile were at risk from lower commodity prices, higher corporate debt and volatile capital flows."

In the U.S., the ISM Nonmanufacturing Index rose slightly from 53.4 to 54.5 and ahead of consensus estimates for 54.0. New orders rose from 55.5 to 56.7 but backorders were flat at 52.0. The employment component increased slightly from 49.7 to 50.3.

Overall, the report was slightly improved but it would be hard to class it as bullish. The gain on the headline number was only the second gain in the last eight months. The component with the biggest gain was exports with a jump from 53.5 to 58.5. That was a real plus because it means the impact of the strong dollar may be fading. Ten industries reported improving conditions while only three reported declining conditions.

The International Trade numbers were worse than expected. The February deficit rose to -$47.1 billion compared to -$45.7 billion in January. Analysts were expecting -$46.2 billion. Exports rose +1% with consumer goods rising +6.7%. However, that barely erased the -5% decline from January. Imports rose +1.3% with consumer goods also leading at +7.5%. Oil imports declined -6% to 275 million barrels.

Moody's Chart

The Atlanta Fed GDPNow real time GDP forecast for Q1 declined from 0.7% to 0.4% growth. Slowing vehicle sales and a decline in consumer spending weighed on the outlook. With a month to go before the March data is reported we could end up with a no growth quarter. The Fed is not going to raise rates in April with the GDP forecast so low.

The economic news for Wednesday is headlined by the FOMC minutes for the March meeting. Given the Christine Lagarde comments today and the six Fed heads over the last week talking about raising rates sooner rather than later, this will be an important insight as to how the meeting went and what to expect in April.

The Fed roundtable discussion after the close on Thursday with Yellen, Bernanke, Greenspan and Volcker is going to be the focus on Thursday and could provide a seriously directional market on Friday depending on what is said and how it is reported.

Crude prices started the day off weak at $35.30 and then improved on comments from a Kuwait official suggesting the production freeze agreement would still be implemented without Iran joining the party. Whether that will actually happen or the deal self-destruct before the April 17th meeting is still in doubt. Regardless, it will have no impact on the actual production and the current glut of oil.

Midday there was a report of an explosion at an Iraqi oil well and prices rose again. Later it was learned that the well was a mothballed natural gas well and had no impact on Iraqi oil production.

After the close the API inventory report said crude levels declined -4.3 million barrels last week compared to expectations for a 3.2 million barrel gain. Prices rose again on the news. However, the API numbers rarely match the EIA numbers on Wednesday morning so prices may have firmed at $36.60 but they are not moving any higher until after the EIA report.

Wynn Resorts (WYNN) shares declined -$2 in afterhours. The company guided to revenue from Macau for Q1 to be in the range of $603-$613 million and down from the $705 million in the year ago quarter. Earnings are expected to decline from $212.3 million to $187-$195 million. Macau gaming revenue has slowed its decline but remains at two-year lows.

Cree Inc (CREE) warned after the close that revenue would come in around $367 million compared to prior forecasts of $400-$430 million. Earnings would be in the range of 13-15 cents compared to prior guidance for 22-29 cents. Shares fell -$6 in afterhours to $23.60.

Darden Restaurants (DRI) shares fell -4% after they reported earnings of $1.21 that beat estimates by 2 cents. Revenue rose +6.7% to $1.85 billion. Sales at Olive Garden stores rose 6.6%, Longhorn Steakhouses 5.4%, fine dining locations 5.4% and other businesses 10.7%.

The chairman of Darden resigned saying he was proud of what he accomplished but he was done. Jeffrey Smith, CEO of the Starboard Value activist hedge fund had taken over as Chairman of Darden after Starboard successfully replaced all of the board after Darden sold off the Red Lobster chain against shareholder wishes in 2014. Shares are up 60% since he took over.

Tesla (TSLA) shares rallied despite missing production estimates in Q1. The company delivered 12,420 Model S cars and 2,400 Model X SUVs. Analysts were expecting 15,000 to 16,000 cars. Musk said the weak deliveries were prompted by a parts shortage on the Model X. He said about 6 of the 8,000 unique parts used in the Model X were delayed by third party manufacturers. Musk said Tesla failed to adequately validate supplier capabilities and producers were running behind. According to Musk, the shortages have been solved and by the last week of March, they were delivering about 750 Model X cars per week. The company said it was still on track to deliver 80,000-90,000 cars in 2016.

The company said it has addressed the producer shortcomings and they will not occur on the Model 3. As of Saturday evening, the company had received more than 276,000 orders.

Amazon (AMZN) and Sprint (S) reached a deal to allow Sprint subscribers to add Amazon Prime service to their Sprint account for $10.99 a month. Yes, that adds up to more than the $99 a year that Amazon charges but customers can pay by the month and cancel at any time.

Twitter (TWTR) beat out Amazon, Verizon, Facebook, Google, Yahoo and Apple to stream live the NFL's Thursday night football games this year. Twitter will pay $10 million to stream 10 of the 16 games CBS and NBC will broadcast. Last year Yahoo paid $20 million for a single game. You will not even have to have a Twitter account to view the games. Twitter has 320 million monthly average users (MAU) and 500 million "additional" users that do not have accounts but view the content from Twitter's website. Many of those users are not in the USA so the deal makes the ten games available worldwide. Apparently, Twitter was not the low bidder but the NFL thought Twitter's user base would be a good place to advertise the NFL by streaming the games. You have to wonder what prices those other tech giants were offering and how much the NFL gave up in awarding the deal to Twitter. Unfortunately, it did not help Twitter shares and they were fractionally negative for the day.

With a steady stream of earnings warnings, the outlook for Q1 earnings has not improved. FactSet is still predicting an 8.5% decline in Q1 earnings and the first time since 2009 for four consecutive quarters of declines. For Q1, 94 S&P companies have warned and 27 have issued positive guidance. The current S&P PE ratio is 16.6 and neither under or overvalued.

Despite the uptick in the Manufacturing ISM and the Services ISM and the drop in oil prices the Dow Transports ($TRAN) have declined for 9 of the last 11 days. Resistance at 8,000 held and today's close was a three week low. This does not bode well for the broader markets. The Dow Transports typically lead the Dow industrials.

The Biotech Index posted another gain in a weak market. That is the fourth consecutive daily gain and this was in spite of the $41 loss in Allergan. This appears to suggest the biotech crash may be over. It will take a rebound above the resistance at 3,250 to confirm but there are green shoots forming.


The S&P never tested real resistance at 2,075 before rolling over to fall back to 2,045. That high at 2,075.07 on Friday was only for an instant and the selling was immediate. However, that lower 2,045 level now appears to be new support. It has been tested multiple times since March 29th and has held each time. This could be a sign the selloff has run its course.

If the 2,045 level fails, the next obvious target is 2,020. However, if you note the 7 weeks of S&P gains in the chart below there have been multiple occasions where there was a 2-3 day pause. The S&P has been trading in a range between 2025-2072 since the middle of March. Because of the short hang time for the S&P at 2,075 on Friday, I believe the next test will be slightly higher high but have the same result.

With the FOMC minutes on Wednesday and worry over the Fed round table on Thursday, traders are not likely to have enough conviction to push through resistance.

The Dow fell back to light support at 17,585 and closed almost at the lows for the day. The stocks that were the biggest losers were from a variety of sectors and there was no rhyme or reason. It was simply a day of profit taking. Pfizer was at the top of the list of winners because of the potential for the Allergan merger to be cancelled. Boeing was the biggest gainer after winning a contract for (20) F16s to be used as target practice at a cost of $34.4 million. The planes can be flown manned or unmanned. They also won a $275 million contract for space work and $235 million for 11 P-8A surveillance aircraft. It was a good day for Boeing.

The Dow could retest support at 17,400 and resistance is strong starting at 17,750. That could provide a range for trading over the next couple of weeks.

The Nasdaq is challenged by the resistance at 4,900 and closed well back at 4,843. Biotechs were the big gainers but the leaders list is a jumble of different sectors. Amazon and Google were big losers, Facebook lost a whopping 33 cents and Netflix gained $1 to round out the FANG contingent.

There was no trend on the Nasdaq other than profit taking from some recent gainers.

The Russell 2000 closed under support at 1,100 and the biggest loser for the day. The small caps have lost their momentum and their volume. It appears fund managers have decided to reduce their small cap holdings and that is not good news for the market. The Russell struggled for 3 days to make any gains over 1,110 and finally failed at that level. If the selling continues, we could see a retest of 1,065.

I am neutral on the market for Wednesday. The dead stop on 2,045 on the S&P decline is somewhat positive and futures are up +6 as I type this. However, the weakness in the Russell and the Dow Transports suggests there could be additional problems. The FOMC minutes could give the market a boost or a shove off the cliff depending on their contents.

I believe we are going to chop around under resistance for a few more days until fund managers decide what they want to do. While April is normally a positive month, all Aprils do not normally have as many negative conditions weighing on the market. If the EIA oil inventories decline on Wednesday that could lift oil prices and equities.

Enter passively, exit aggressively!

Jim Brown

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