The Dow and S&P both made another lower high on Friday as the early morning rally faded almost immediately. They remained in positive territory for the day but lost ground for the week.

Market Statistics

Friday Statistics

The Dow and S&P both failed to return to the highs set last Friday and Monday's open was the high for the week. Both set a lower low on Thursday and barely held above that low on Friday. The indexes are trapped in a congestion range below major resistance levels. Both indexes touched that resistance the prior Friday but it has been downhill ever since. Conviction is fading with volume barely over 6 billion shares on Friday and we are not even in the summer doldrums yet.

Thursday's decline was blamed on the Japanese Yen and the Yen carry trade blowing up. When the Yen is cheap hedge funds can borrow for almost zero interest and then buy U.S. and European stocks that pay hefty dividends or are in growth mode. When the Yen rallies it is like an interest rate hike on those loans and investors are forced to sell the stocks and pay back the loans.

Friday's rally was blamed on rising oil prices except oil gapped open to $39.50 and never declined below $39.25 to post a 6.4% gain for the day and close at $39.75. The equity markets gapped open with oil but then rolled over immediately and closed near the lows for the day. The Dow was up +153 at the open and closed with only a 35-point gain after trading in negative territory late in the session.

The talking heads on TV will blame market movement up or down on something every day. They will pick the easiest excuse and run with it all day. Whether or not that is the right reason is immaterial. It is a headline and gives them something to talk about and sound intelligent. It is better than saying, "the market is down triple digits and we do not know why."

On Friday, they could have blamed economics for the decline because the numbers are worsening nearly every day. The Wholesale Inventory report for February declined -0.5% after a previously reported +0.3% increase in January. However, that January increase was revised down to -0.4%. The February inventory number is the lowest since May 2015. Durable goods sales rose +1.2% but nondurable sales were down -1.6%. Sales declined -0.2% and the inventory to sales ratio declined from 1.37 to 1.36.

Moody's Chart

The sharp drop in inventories caused a sharp drop in GDP forecasts. The Atlanta Fed real time GDPNow forecast declined to only 0.1% growth for Q1. That was a drop of -0.3%. By comparison, Morgan Stanley is now predicting 0.3%, Barclays 0.3% and Moody's 0.1%. Historically the GDPNow forecast has been the most accurate. If the actual number comes in anywhere close to this it will be the fourth consecutive quarter of declining growth. Regardless of what the Fed says they are not going to raise rates with GDP growth at zero.

The Thursday night event with Yellen, Bernanke, Greenspan and Volcker was a bust. It had the potential to be filled with fireworks but came off as a yawner. About the only points worth repeating were Yellen and Bernanke claiming the U.S. economy was strong. Considering the GDP information in the prior paragraphs you have to think they are either delusional or flat out lying for reasons we do not understand. Yellen also said the rate hike in December was the right move. (Never admit you made a mistake)

For Yellen to claim the U.S. economy is strong she has to be comparing it on a relative basis to the rest of the world but even that is a weak comparison. With seven Fed heads now talking about rate hikes sooner rather than later it makes you wonder if they are pumping happy gas into the halls of the Federal Reserve. We do know that the Fed has resorted to Fedspeak in the past to create volatility in the bond market and keep interest rates elevated when they could not actually hike rates for economic reasons. I have to believe this is what we are seeing today in this new era of Fed communications. If the Fed is trying to hype rates they are doing a poor job and losing credibility. The yield on the ten-year treasury declined to 1.685% intraday on Thursday and nearing a three-year low.

This apparent hurry to hike rates is putting a cloud over the market and we have seen the impact over the last two weeks. It will only get worse if the economics continue to decline and the Fedspeak does not lighten up.

The calendar for next week has seven Fed speeches and a deluge of economic data from China. If that data is positive it could lift the U.S. markets but it would accelerate Fed action because Yellen emphasized they were watching China and the global markets as a threat to the U.S. economy. If China appears to be healing then the Fed could check them off the problem list. The Fed speakers could mention that in their appearances.

The Fed Beige Book on Wednesday is expected to show conditions are growing very slowly in the 12 Fed regions. If there is any worsening of those conditions the market could weaken.

Retail sales on Wednesday could also be a challenge after the Gap warned on Friday about rapidly slowing sales in the malls. The business inventories on Wednesday could push GDP estimates to zero or below if the numbers come in below expectations.

The Q1 earnings cycle begins this week with Alcoa on Monday, JP Morgan on Wednesday, Bank America and Wells Fargo on Thursday and Citigroup on Friday. With weakened expectations it will be interesting to see if the financial sector can exceed those low estimates or miss the already lowered bar.

Late Thursday the Fed sent out a notice of an "Advanced Notice of a Meeting Under Expedited Procedures." The meeting is scheduled for 11:AM on Monday and the topic is "discount rates." There was an uptick of alarm in the market but it quickly died. Apparently, these happen routinely but do not make the headlines. John Mauldin said there were five such meetings in March and the topics were, bank supervisory meeting, discount rate, monetary policy issues, bank supervisory matter, and discount rate again. These meetings are closed and not for public information.

Yahoo (YHOO) was in the news on Friday after they extended the deadline for bids from April 11th to April 18th. Verizon, Google and Time Inc are reportedly still planning on making offers. Private equity firms Bain and TPG are also reportedly preparing offers. However, AT&T, Comcast, Microsoft, SoftBank and Alibaba have all decided to pass on the auction. At this point, I would expect Verizon to end up as the winner but you never know if an unknown entity will surface with a surprise bid.

It was revealed on Friday that the financial documents given to the prospective bidders show Yahoo expects revenue to decline -15% and earnings decline by more than 20% in 2016. Apparently, Yahoo has not embraced the move to mobile and they are losing out on revenue from mobile consumers. Analysts said Yahoo has been buying traffic to keep up the popularity of its existing websites and that is costing them nearly as much as they are making on those sites. There is a distinct possibility of a "take under" instead of a takeover with earnings rapidly declining. Yahoo shares were down slightly on the news.

Ruby Tuesday (RT) reported earnings of 3 cents that missed estimates for 5 cents. Revenue fell -5.1% to $271.5 million and missed estimates for $283 million. Same store sales fell -3% and worse than the -0.3% decline in Q4. The company lowered full year guidance from 12-17 cents to 5-8 cents. They also announced the CFO would resign on Monday. It was not a good day for RT.

The Gap (GPS) soured the entire retail sector on Friday. The company said revenue for the five-week period ending on April 2nd fell -6.5% and a bigger drop than the -3.3% in February. Same store sales crashed with Gap stores -3%, Banana Republic -14% and Old Navy falling -6%. This was the 12th consecutive month of sales declines. The company said inventory levels were high and would depress margins. Markdowns would be heavy and earnings would suffer. The company said it suffered from some problems with fabrics that did not work and styles and fit that failed. In one assortment from the Banana Republic the average consumer could not get their arms through the arm hole. Gap said that was easy to fix by just removing the products and replacing with the next seasonal fashion but it will be an expensive mistake. Mall traffic was continuing to be a problem. Shares dropped 14% on the news.

Sometimes you just have to be in the right place at the right time. Ulta Salon (ULTA) was named to replace Tenet Healthcare (THC) in the S&P-500 at the close on April 15th. Tenet is moving to the S&P-400 Midcap where it will replace Jarden Corp (JAH) after it is acquired by Newell Rubbermaid (NWL). Tenet has declined from $6 billion market cap to $3 billion and fits the midcap index better than the large cap according to S&P. ULTA has a $13 billion market cap. ULTA rallied to a new high at $200 on the news.

Linkedin (LNKD) was downgraded from buy to neutral at MKM Partners because online job postings appear to have peaked. MKM said job growth was slowing and that had a direct impact on Linkedin. Online postings had risen since the market bottom in 2009 until 2016. Postings in Q1 declined for the first time in six-years. MKM cut sales and earnings estimates for 2016 and 2017. The broker said expectations are low and the value collapse was overdone but it could take multiple quarters for sentiment to improve.

Valeant Pharmaceuticals (VRX) has a new leader. Bill Ackman is only a board member but he appears to be speaking for the company. He said on Friday Valeant will not sell the Bausch & Lomb brand because it is a core asset and the company is not selling core assets. He said "we" are willing to break up the company but "we" are not willing to sell B&L. Sounds like he has taken control.

Valeant's market cap has fallen to only $10 billion and selling B&L could get them $10 billion to as much as $20 billion in cash. However, B&L has been growing rapidly and has generated up to 40% of the company's revenue. The company does not provide a brand breakdown of revenue but analysts are speculating since the business has grown significantly since Valeant acquired them for $8.7 billion in 2013. Valeant has $30 billion in debt so selling B&L would allow them to pay down a significant portion and improve their outlook.

A Stifel analyst has assigned a $65 breakup value to Valeant but a BMO analyst thinks the company is worth $118 per share using the sum of the parts method.

CEO Michael Pearson was under subpoena to appear before a Senate committee on Friday and he failed to appear to answer questions on drug pricing. Senator Susan Collins and Claire McCaskill said "it is our intent to initiate contempt proceedings against Pearson." Pearson's lawyer said the Friday hearing was unfair and he should not be required to give testimony without being advised in advance, about what topics and documents he will be questioned about. The company said Valeant has supplied "thousands of pages of documents." He is also under subpoena to appear on April 27th for another panel to discuss pricing. Valeant said he would appear at that committee hearing.

Alliance Fiber Optic Products (AFOP) shares spiked 19% to $18.45 after the company CEO sent a letter to employees saying Corning (GLW) intends to acquire all the outstanding shares for $18.50 in cash of $350 million. Corning has not yet made the offer but it is expected within the next 10 days and will be effective for 20 days.

Tesla (TSLA) shares gave back some of their gains on Friday after receiving more than 325,000 orders for the Model 3 in the first week alone. That represents a $325 million no interest loan for Tesla for the next three years. If all those deposits turn into completed sales that would equate to $14 billion in revenue. However, since inception Tesla has only built about 100,000 cars although it is on track to deliver about 85,000 in 2016. How will it produce 325,000 cars when its current pace is only about 85,000 a year? Elon Musk said they were rethinking their production plans and that could mean they will have to build an even larger manufacturing facility.

This also means we should expect another secondary offering in the next few months because ramping up to produce that many vehicles, in addition to the Model S and Model X production, will cost a lot of money. Tesla's current market cap is about $33 billion and Barclays thinks the automaker may need to raise another $3 billion to expand capacity and meet the surge in demand. Since they already have $2.64 billion in long-term debt, the obvious answer would be a secondary offering. They could easily justify going back to the equity market because of the extreme surge in demand for the Model 3.

Tesla bought the final assembly plant in Freemont, California that was initially owned by a joint venture by GM and Toyota. It has the capacity to build 500,000 vehicles annually. Analysts say the real question is whether Tesla buys/builds another assembly plant in order to guarantee production quantities of 500,000 cars a year by 2020. That is the volume Elon Musk is predicting. Making that many cars in multiple models would best be done in multiple facilities in order to have room for growth.

To raise another $3 billion Tesla would have to sell 12 million shares at the current price of $250 a share. Tesla has 132 million shares outstanding so that would be less than a 10% increase.

Top speed on a Model S is 155 mph.

The FactSet earnings estimates dropped again for Q1. The S&P-500 companies are now expected to see earnings decline -9.1% compared to -8.4% a week earlier. This will represent the fourth consecutive quarter of earnings declines and the first time since 2009. However, Citigroup is now claiming the estimates are too low and predicting a 4% beat over the lowered numbers. That is not a stretch of the imagination since the S&P has beaten earnings by 4% on average every quarter for the last four years.

This is the wildcard for this earnings cycle. Will a beat on extremely low estimates be seen as a beat or just "less bad" results. Assume a company reported 95 cents last year and was expected to report $1.00 in Q1 before the estimates were lowered to 85 cents. If they report 90 cents is that worthy of a rebound in the shares or is it still bad earnings? I view it as still a miss but we have seen earnings rallies on this type of cycle before.

Revenue is expected to decline -1.2% compared to estimates on Jan 1st for a 2.7% rise.

Crude prices spiked about 8% for the week to $39.66 on hopes for an agreement at the April 17th Doha meeting. You might as well believe in the tooth fairy. There is little or no hope that an agreement will be reached and zero hope that any potential agreement will have any impact on production. Apparently, traders are a gullible group.

Prices also rebounded this week after there was an unexpected 4.9 million barrel decline in U.S. inventories. The headlines were full of titles like "crude glut shrinking" and "production declines reduce inventories." Nothing could be farther from the truth but the press never lets the truth get in the way of a sensational headline.

The Doha agreement, if it happens, will likely not include Iran, Libya, Iraq or the UAE. All of those countries are raising production from current levels rather than freezing production. The UAE is expanding production from 3.1 mbpd to 3.5 mbpd by the end of 2017. Iraq has been producing an average of 3.494 mbpd so far in April. That is up from 3.286 mbpd on average in March. Iraq is expanding production to 6.0 mbpd by 2018. Libya has very little current production. They are trying to quell the fighting and make deals with the rebels in order to return to the 800,000 bpd they produced in 2014 on the way to the 1.6 mbpd they produced before Gaddafi was overthrown.

Saudi Arabia has 128 active rigs and they are planning on increasing annual production through 2020. Saudi Arabia and Kuwait agreed last week to restart production of 300,000 bpd from the disputed zone that has been halted for the last two years.

Iran is producing between 2.4 and 2.6 mbpd and is targeting 4.0 mbpd by the end of 2017.

Currently there is a minimum of 1.0 million bpd of excess production and probably more. Goldman Sachs said on Wednesday they expect OPEC production to rise 600,000 bpd in 2016 and another 500,000 bpd in 2017.

Given the facts I have outlined above any agreement to freeze production by the countries I did not mention will have zero impact on current production and future increases. A post meeting announcement that claims a production freeze may lift prices temporarily because the headline traders will think the problem is solved. Several days later reality will return and the entire three-month lead up to this event will be forgotten.

U.S. inventories declined for multiple reasons. Imports declined by 500,000 bpd last week after a -630,000 bpd drop the week before. Over the last two weeks total imports declined by -12.3 million barrels. Obviously, there is a reason. I research it and the Houston Ship Channel was closed because of fog for multiple days last week. I am assuming that was the problem the week before as well because there were 26 tankers outside the port waiting for permission to enter and make deliveries. If each only carried 1 million barrels that would be 26 million. Some may be smaller but I am sure there were some VLCC tankers (2.0 mb) in the mix.

That would have been enough to cause a serious drop in inventories but there was another problem last week. TransCanada shutdown the 590,000 bpd Keystone pipeline that moves crude oil to Cushing Oklahoma and Illinois. That was shut down last Saturday and it will be reopened this Saturday once approvals are received. That means another 2 to 3 million barrels did not make it to their destination this week. That suggests more volatility in inventory levels in next Wednesday's report. Canadian select crude was trading as much as $15 below WTI because of the outage and it was instrumental in boosting WTI prices late in the week.

Active rigs declined to another historic low dropping -7 to 443. Oil rigs declined -8 to 354 and gas rigs rose 1 to 89. U.S. production declined 14,000 bpd to 9.008 mbpd. We are likely to get a production number that starts with an 8 this week.

The Investors Intelligence Survey showed a 5% spike in bullish sentiment and -4.3% decline in bearish sentiment. Interesting that the bulls started getting excited just as the market started rolling over.


The overextended market conditions are starting to ease. Two weeks ago, the percentage of S&P stocks trading over their 50 day averages reached an eye-popping 95%. That has declined to 84.6% and still falling. Obviously, the high number was caused by the sharp decline in February that dragged the averages lower and then the rebound allowed stocks to pass those short-term averages on the way back up. The average is about 55-60% so just returning to the averages would mean 30% of stocks would move lower.

The percentage over the 200-day average rose to 63% and pulled back only slightly. This is the bottom range of what we would call normal as indicated by the first six months of 2015. This percentage has likely run its course and should also decline slightly as the January/February dips equalize.

The percentage of S&P stocks with a buy signal on a Point and Figure chart has also plateaued and should move sideways around the 70% level. This is neither bullish nor bearish but indicates the overbought market is equalizing.

The Wilshire 5000 Index has a troubling pattern on the quarterly chart. It shows 3 consecutively lower quarters with the April quarter starting our lower as well. The relative strength (RSI) is fading and the MACD is about to flash a sell signal. This is a long-term chart so it is not something you should run out and sell on Monday morning. This is just another cautionary indicator of a weak market and this index covers the entire market.

I have shown this monthly chart of the S&P before but I thought I would refresh it. The 10-month average has completed its close under the 21 month and this is a long-term technical sell. Because it is a monthly chart, it moves very slowly but the trending averages are good indicators of market direction. Past performance is no guarantee of future results but it has been flawless for the last 20 years.

What a difference a week makes. When I showed this chart last week the indicators were just starting to roll over and now all three are in decline. The S&P failed at 2,075 and support at 2,020 is now the target followed by 2,000 if the decline continues.

I think it is clearly evident that the weakness is accelerating and we could be looking at some rocky trading next week. However, it does not have to move straight down. It is more than likely going to be choppy with some alternating triple digit days like those that we saw last week.

The Dow chart is similar. The Dow tested resistance at 17,750 and immediately sold off. The indicators have all flashed sell signals and the next support level is 17,400 followed by 17,135.

The Dow will be heavily influenced by the financial sector next week. With all the major banks reporting and having already guided lower they could rebound on a minor beat of the lowered numbers or crash even lower if they miss their revised guidance. Goldman Sachs does not report until the following week but they will react to whatever JP Morgan reports on Wednesday.

The Nasdaq has not fallen as far into the selloff as the Dow and S&P thanks mostly to the rally in the biotech sector. That helped lift the Nasdaq almost to resistance at 4,926 and it traded over 4,900 for a couple days. The oscillators are finally starting to roll over and the target on any real decline is about 4,735.

The Biotech Index ($BTK) is fading from that monster short squeeze to 3,250. After trading there for two days the index has dropped back 100 points to 3,155 and the direction is unclear. Most of the decline came on the open on Friday and it was flat in the afternoon. This may be just a bit of profit taking before the weekend event risk and it could take off again next week. OR, the short squeeze could fade completely and we return to the prior range. There was no fundamental reason for the rebound other than it was severely oversold and several companies reported successful drug trials and the shorts began to get worried. The direction of the BTK should be a big influence on the Nasdaq next week.

The Russell 2000 came to a dead stop at that 50% retracement level of 1,120. After trading there for three days, the index rolled over to close back under 1,100 again. The oscillators are not as bearish as the Dow and S&P but they have turned negative. The key level here is 1,065 and it is not that far away. The 1,120 level should remain strong resistance.

I believe the market is showing a classic topping pattern and after three weeks of sideways movement, we are at risk of retesting support. That would be 17,400 on the Dow and 2020-2025 on the S&P. If earnings are better than expected we could see a bounce but they would have to be much better to push through resistance. Somewhere over the next three weeks there is probably a sell the news event where some key stock or stocks really disappoint and investors get a head start on the sell in May cycle.

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Random Thoughts

No Random Thoughts this weekend. Our power was out all day on Friday and I am too far behind today. This section will return next weekend.


Enter passively and exit aggressively!

Jim Brown

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