The news powering the market today came from Russia's Interfax news service claiming Russia and Saudi Arabia had agreed to freeze production even if Iran stays out. The report was unconfirmed.
Crude prices exploded higher to close at $42 and a four-month high on a "rumor" those two oil producers have agreed. You may remember last week when the deputy crown prince Mohammad bin Salman Al Saud said Saudi would only participate in a production freeze if "major producers, including Iran, also participate." Obviously, he could have changed his mind but there are dozens of news articles, comments and quotes over the last three weeks that confirm his position.
The biggest point to this entire dog and pony show is that freezing production at the current level still leaves 1.45 million barrel per day in excess production and that number is growing daily as Iran, Libya and Iraq continue to ramp up production. Those three countries have already said they would not participate in the freeze.
The key here is that the OPEC leaders and Russia have figured out how to spam the headlines with positive comments in order to boost oil prices. Eventually gullible investors are going to realize that global inventories are continuing to grow and prices will decline. John Kilduff, a partner at Again Capital and energy analyst said "This could be the mother of all buy-the-rumor, sell-the-news events."
For today, the spike in oil prices to $42.17 caused a major short squeeze in energy equities. That squeeze carried over into the broader market and we saw the major indexes return to prior resistance levels.
Short squeeze examples from the energy sector.
The oil story captured a lot of headlines because there were not a lot other news events to capture attention. The NFIB Small Business Survey for March declined slightly from 92.9 to 92.6. This was the third consecutive monthly decline and well below the 96.0 reading in October. Of the ten component categories, only two posted a gain and that was plans to increase capital expenditures and improving credit conditions. Analysts blamed unrest in financial markets as the reason for the continued decline in small business sentiment.
Import prices for March rose +0.2% after a -0.4% decline in February. Analysts were expecting a +1.2% rise. However, if you exclude oil imports, prices declined -0.2%. If you exclude autos prices declined -0.3%. Petroleum product prices rose 6.5%. Export prices were flat after a -0.5% decline in February.
The only real surprise for the day came from the Treasury Budget for March. The deficit was -$108.0 billion compared to -$192.6 billion in February. That compares to -$52.9 billion in March 2015. Government revenues declined -2.7% to $227.8 billion while spending increased +17% to $335.9 billion. So far, in fiscal 2016 the government has incurred a cumulative deficit of $461 billion. Individual income taxes fell -10.3% because of the drop in full time jobs and sharp increase in lower wage part time jobs. Self-employment tax receipts declined -3%. Medicare spending rose 87.2% with Medicaid spending up 14.7% because of the Affordable Care Act. Interest payments on the debt rose 51.8%.
Wednesday is a big day for economics with the Retail Sales for March and the Fed Beige Book. The retail sales for March could easily disappoint with multiple retailers warning about Q1 results. The Fed Beige Book should not be a problem for the market unless several of the regions report declining economic conditions.
Starbucks (SBUX) needed some extra caffeine this morning after being downgraded by Deutsche Bank from buy to hold. The bank said customer traffic might slow after the company changed its loyalty program last month. Starbucks changed the program to reward customers on dollars spent rather than store visits completed. The program offers free food and drinks after they spend money in the stores. Currently customers are awarded 2 stars for every dollar spent. That was a change from receiving one star for every visit regardless of the money spent. Under the old system you received a free food item for every 12 stars accumulated. Under the new system, you have to accumulate 125 stars ($62.50 in spending) to reach the same benefit level. At the end of December, there were 11.1 million rewards customers, up 50% over the last two years. The analyst said the stock was fully valued and cut his price target to $64.
L Brands (LB) was downgraded by Goldman Sachs (GS) from buy to neutral. They also removed the company from their conviction buy list. They lowered the price target from $115 to $91. The downgrade came on worries about the current restructuring process that will split the organization into three business units, Lingerie, PINK and Secret Beauty. Goldman said the split could cause near term sales growth to slow.
Horizon Pharma (HZNP) shares fell -26% after the company provided disappointing guidance. The company reiterated the guidance from January for revenue of $1.025 billion to $1.050 billion and EBITDA of $505-$520 million. However, they pushed out the expectations for this not to happen until later in the year. Q1 guidance is only expected to bring in 19-20% of the total with 22-23% in Q2 and 57-59% in the second half. Approximately 64-66% of EBITDA is not expected until the second half. Investors do not like delays and revenue shifts. Shares crashed on the news.
Integrated Device Technology (IDTI) shares rallied as much as 23% on a reported buyout bid for $32 a share in cash. That would have been a 65% premium to Monday's close. However, almost immediately the purported bid began to be questioned. There were some analysts claiming it was a "fakeover" bid similar to one made on another company in 2015. Someone uploaded a fake 13D document to the SEC website just to spike the price. Tuesday's reported bid from a group of investors led by Libin Sun could not be verified. Even if the bid was real there is a good chance the government would not approve it. Libin Sun owns 4.4 million shares. The 13D uploaded for IDTI said the bid was nonbinding and included a go-shop provision. We should know in 24 hours if the bid is real. IDTI and the SEC declined to comment on the filing. Shares dropped back to only a 4% gain on the questions over legitimacy.
A brave investor could buy the May $21 calls for $1.00 in case the bid turns out to be real.
Facebook (FB) kicked off its developer's forum and there was plenty of hype. The company said it was going to promote its Messenger platform as a way to sell products over the Internet and offer customers support. Currently users send 60 billion messages a day. Zuckerberg spent a lot of time in his keynote speech talking about bridging borders and expanding the Internet to everyone, everywhere. Of the 2,600 developers in attendance one-third were from other countries.
Zuckerberg talked about using lasers and drones to make the Internet available to everyone. With 7.1 billion people in the world, more than half do not have Internet access. He talked about using virtual reality to bring friends together using a pair of normal looking glasses. He has been spending a lot of time in China and India in an effort to bring those 2.5 billion people online with Facebook. Neither country allows Facebook. India just rebuffed his offer to supply free Internet along with a limited Facebook to their population.
Eventually China and India will concede and allow some form of Facebook into their borders. This is why you have to have a position in Facebook at all times. One morning we are going to wake up to an announcement that China has agreed to let Facebook in and the monthly active users will jump by one billion almost immediately. Recently some analysts have started to cut estimates on Facebook saying it has peaked. While user growth may have slowed, it is far from peaked. Users could actually double when, not if, he is successful in getting the product into China and India.
Chipotle Mexican Grill (CMG) is expected to report its first quarterly loss ever for Q1. They are expected to report a 29% drop in same store sales after their multiple food contamination issues in prior months. Also, customer traffic is expected to have declined -26%. Long time customers may have become accustomed to eating elsewhere after they avoided Chipotle during the period where the food scare was active. In order to counter the declining traffic Chipotle handed out 26 million coupons for a free burrito. This will also impact their margins as those customers redeemed those coupons. They report earnings on April 26th. There is actually a chance for either a surprise beat or more likely a "kitchen sink" quarter. Since they know the estimates are lousy, they could throw all the bad stuff into this report to clear the runway for future quarters.
After the bell, CSX Corp (CSX) reported earnings of 37 cents that matched estimates. Revenue of $2.62 billion declined -14% and missed estimates for $2.68 billion. Coal shipments declined -33% dragging total traffic lower by -6.5%. CEO Michael Ward said the railroad was parking locomotives and unused cars and reducing employees until conditions improved. He also said the intermodal business rose 11% because of the severe driver shortage for over the road trucks. To combat this, the truck lines are shipping more trailers by rail and using their drivers to pick up and deliver from the rail yards. The earnings were not as bad as some expected and shares were flat in afterhours.
Also after the bell, Valeant (VRX) got some bad news. Last week the company reported a deal with bondholders to postpone a potential technical default event by gaining approval for a late filing of their 10K. Tonight Centerbridge Partners sent Valeant a notice saying they intend to call a default. This means Valeant will have 60 days to file its annual report or be forced to repay what it owes Centerbridge before that 60 days expires. Reportedly Valeant owes Centerbridge $250 million. If Valeant were to default on those bonds, it would trigger default provisions in the other $32 billion it owes to other creditors. Valeant said the notice does not change anything. They plan to file the 10K by April 29th even though they have an agreement with creditors for a May 31st deadline. Analysts said the move by Centerbridge could be an attempt to win additional concessions in negotiations with Valeant. Lenders have used these tactics for decades to leverage their position. Centerbridge may have given notice simply to insure Valeant does what it has promised in producing the reports in a timely manner. Valeant shares were down $1 in afterhours.
The Q1 earnings cycle kicks off for real in the morning with Dow component JP Morgan reporting before the open. JPM is the first of the top 5 banks reporting over the next five days. These earnings have the potential to set the tone for the entire quarter.
Q1 earnings are still expected to decline -9.1% and the biggest quarterly decline since Q1-2009. On the S&P 121 companies issued guidance and 78% guided lower. Estimates for Q2 are for a -2.7% decline, Q3 +3.8% growth and Q4 +11% growth. Obviously if the market can get through the Q1 earnings with any kind of improvement from the estimates, we will see investors start to load up on stocks ahead of the second half of 2016. Whether that happens in May or July remains to be seen.
Today's short squeeze could continue a long way if there was something to power it higher. As much as 4.5% of the float of the U.S. markets is short. That is near record levels. The short interest in the SPY is at record levels. Globally there is $12 trillion sitting in cash in investor accounts. If an economic rebound broke out there would be a monster rally in equities.
In order for the short squeeze to continue, we have to break through that monster resistance above the Dow and S&P. The S&P close at 2,062 was right at initial resistance but it has 13 points it has to scale to reach the real resistance that starts at 2,075. Just getting there will be a challenge and getting through the multiple resistance levels to make a new high at 2,132 would be a serious undertaking.
I am not going to write a book about the resistance challenge because I have written about it every day for the last three weeks. Support is now 2,042 and resistance 2,062 and 2,075.
All 30 Dow components were positive today and that is a rare occurrence. Chevron led the pack because of the oil story. Tomorrow JP Morgan will lead and probably determine the direction. Resistance on the Dow begins at 17,750 through 17,925. That is going to be a tough minefield to cross. Support is about 17,550. The Dow has moved almost perfectly sideways for almost a month. That next 80 points is going to be a challenge.
The Nasdaq came to a dead stop at 4,900 last week and has failed to return to that level in the last four sessions. The short squeeze in the biotech sector ended and today the semiconductor sector was negative. Every day it is a different drag but next week the big techs begin to report and the gains/losses will be headline driven.
The morning drop today to 4,808 broke through the recent support at 4,835 but the rebound was quick. The index ended the day right in the middle of its recent range after making that lower high, lower low for the day.
The Russell 2000 remains stuck below resistance at 1,110 but turned in a respectable day with an 11-point gain. The Russell remains captive to the biotech sector, financials, semiconductors and energy stocks. Those energy stocks offset the losses in the other sectors on Tuesday.
Tomorrow is all about earnings and oil. The API inventories tonight showed a 6.2 million barrel build and WTI traded about 70 cents lower at $41.50 but then stabilized to wait on the EIA numbers on Wednesday morning. Cushing inventories declined -1.5 million barrels because the 590,000 bpd Keystone pipeline was halted for seven days. That pipeline flows into Cushing Oklahoma. However, we should see the EIA inventories build because of the backlog of tankers waiting to unload in Houston after those fog closures of the Houston ship channel the prior two weeks. Even if the EIA inventories show a big build as expected, the price of crude will probably not decline much because everyone is waiting for some miracle in Doha this Sunday.
The S&P futures have not declined tonight. They have been flat to slightly positive and after a big short squeeze like today, they would normally be down several points. There is a lot of darkness before the dawn so anything is still possible.
I am neutral on the market for Wednesday because it will be headline driven with earnings and economics. I am bearish on the market in the days ahead because of the strong resistance. However, if the first few companies to report, beat the street estimates and rally then we could easily see a longer term short squeeze because of that strong resistance. As the indexes pass through it, those short at those levels will be forced to cover.
Enter passively, exit aggressively!
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