The Brexit driven sell-off deepens as traders around the world wonder... what now? The question is many faceted but the most pressing may be, when will the Brexit actually occur? Or maybe, will it actually occur? Just because they voted to do it doesn't mean it will necessarily come to pass, at least according to some of the analysis I've seen. To make it happen the prime minister has to invoke Article 50 of the Lisbon Treaty, the article outlining how a nation may voluntarily leave the union, since David Cameron is stepping down that might not happen until the fall. There is also a theory that the EU will make concessions to the UK which may provide reason enough for them to stay. In either case the PM has put the kibbosh on a second referendum saying the people have voted, now the nation has to honor it.

Asian markets did not react to the Brexit in quite the same way as the EU and US market did on Friday. Mainland Chinese indices closed flat to negative while the Hong Kong index, Japan and many other major indices in the region were able to make gains. Of note, Japanese Prime Minister Shinzo Abe told the finance minister, after an emergency meeting with the BOJ, to take whatever steps necessary to stabilize the yen following the wild surge it saw last week.

EU indices did not post gains today. Indices across the region lost at least -1%, most in the range of -2% to -3%, led by the STOXX 600 -4.10%. Later in the day, after the close of the European session, Britain and the BOE received credit downgrades from Standard & Poors and Fitch.

Market Statistics

Futures trading indicated a major sell-off in US equities from the earliest electronic trading. The major indices were indicated to open with losses greater than -1% for most of the morning with some volatility throughout the morning. At the open indices did indeed post a -1% loss in the first minutes of trading and then extended that loss to greater than -2% by the low of the day. Lows were reached by 11AM at which time a near term/intraday bottom was put in. From that point forward the indices were able to bounce but did not recover more than about 1% of the days losses before it was exhausted. Late afternoon saw the indices fall back toward the day's low where they bounced again. The late day bounce carried into the close of trading but left the indices with losses in the range of -1.5% to -3%.

Economic Calendar

The Economy

The advance report on International Trade In Goods And Services was the only official economic data released today. The report shows a -$60.6 billion deficit in trade, greater than the -$50.4 expected by economists and the -$57.5 deficit reported for April.

There will be quite a few major reports later this week. Tomorrow the 3rd estimate of Q1 GDP is due out at 8:30AM. The consensus is for it to be revised higher to 1% from 0.8%. Also on tap tomorrow is the Case-Shiller 20 City Index and Consumer Confidence. Wednesday Personal Income & Spending and Pending Home Sales are due. Thursday we'll see weekly jobless claims and Chicago PMI. Friday we'll get Auto/Truck sales, ISM Manufacturing and Construction Spending.

Moody's Survey of Business Confidence rose 0.7% to 26.3. The caveat is that it may not fully reflect the Brexit vote which was announced Friday, the last day of the survey. According to Mark Zandi global business sentiment appears fragile, most worrisome is South America where political upheaval continues. The US is seen as the strongest with an economy expanding consistent with its potential.

According to FactSet 10 S&P 500 companies have reported earnings for the 2nd quarter so far this season. Of those only 4 have beaten on earnings while 5 have beaten revenue estimates. Since the beginning of the 2nd quarter 9 sectors have been revised lower. The blended rate for 2nd quarter earnings is now -5.2%, the lowest level to date. The energy sector remains the number 1 contributor to earnings decline, ex-energy the expected rate of decline is -1.7%. The two sectors, not energy, with the largest downward revisions to earnings growth are Info Tech and Industrials led by Apple and GE, both companies with large exposure to business outside the US.

Looking forward the earnings picture continues to deteriorate. Q3 and Q4 have both seen estimates reduced by a tenth, both are now at new lows. Q3 growth is expected to be positive, 1.2%, with that growth expanding to 7.5% in Q4. To put this in perspective, last year at this time Q4 was projected to see growth in excess of 15%. Growth has also been revised lower for the full year 2016, to 0.7% from 0.8%. 2017 estimates remain steady at 13.6%.

The Dollar Index

The Dollar Index continues to surge in the post-Brexit referendum world. The index gained another 1% in today's session following a greater than 2% surge last Friday. Post referendum the GBP and EUR are both losing ground to the dollar in a flight to safety trade while the JPY is gaining versus the dollar. On the central bank front the the FOMC was more dovish than expected and now, post-Brexit, some pundits see a possibly of reducing interest rates, not raising them. And at the same time Japan continues to posture towards monetary action to stabilize the yen. Looking forward the waters are muddy to say the least. The current move higher appears to be strong, the candles are extremely long and white and confirmed by a strong signal from the indicators. It looks like the index will at least continue to test resistance near $96.50, the 50% retracement line, with a possible move higher. If resistance is broken a move up to $97.50 is likely.

The Oil Index

Oil prices fell again today. The price of WTI fell more than -2.5% intraday, closing with a loss of -2.4%, on a stronger dollar and persistent oversupply. Not only has the Brexit affected the dollar, it is also calling global growth into question and by extension demand for petroleum. At the same time global production remains high which is adding downward pressure to prices. Market rebalance may be on the way, but it isn't here yet, so prices are likely to remain low without additional catalyst. $50 is looking like strong resistance at this time, first target for support is near $45. A break below $45 could go as low as $40 before finding next support.

The Oil Index fell more than -3% in today's move. The candle is long and black, extends the move below the short term moving average and breaks through support at the bottom of the recent 3 month trading range. The indicators are mixed but generally support a test of support, if not a move lower, with downside target near 1,050... provided oil prices do not snap back.

The Gold Index

Gold prices are moving higher on flight to safety, and are disconnecting from the dollar ... at least for now. Spot gold closed with a gain of 0.42% in today's session, adding $5.50 to Friday's settlement price. The move is an extension of the +$50 move sparked on Friday. Momentum is to the upside with resistance targets near $1350. Goldman Sachs raised its average price target for 2016,2017 and 2018 by roughly 10%, to $1250, and has added Barrick Gold to its conviction buy list.

The gold miners are moving higher in the footsteps of gold. The miners ETF GDX gained nearly 1% in today's session, and is trading above my previous resistance target of $26.50. The move in gold, along with forward outlook, is supporting the miners and could carry them higher into the short term. Nearer term there is potential resistance near $27.50, a break above this level could take the ETF up to the $30 level. The indicators are turning bullish but remain weak; MACD has just turned bullish while stochatic is showing a weak bullish crossover. Based on the candles it looks like there are sellers present at current levels but are likely profit takers. A consolidation at these levels before moving higher would be good for longer term bullish prospects.

In The News, Story Stocks and Earnings

The news wasn't all Brexit, believe it or not. On the M&A front Medtronic announced the purchase of Heartwave for $1.1 billion. The deal is worth $58 per share in cash to shareholders, a 93% premium to Friday's closing price. Heartware makes diagnostic tools and treatments for heart failure, the addition is expected to be accretive for Medtronic by the 3rd year. Shares of Medtronic fell nearly -2% on the news but sellers stepped in to support prices, leaving the stock with a loss of only -1.4% at the close of the session.

The VIX fell about 10% in today's session and is already showing signs of topping. Today's action began with a move to the upside, extending the Friday gains, but met resistance and sent the index into retreat after hitting the early high. Today's candle is black with a large upper shadow, indicative of resistance at the $25 level. At the same time both indicators are confirming potential resistance at this level. The MACD is rising, but the current peak is divergent from the index, while the stochastic is rolling over, below the upper signal line, following a bearish crossover. If this signal plays out the index could easily return to test support near the $20 level. However, with the current situation with Brexit uncertainty and us on the cusp of a poor earnings season I think it too soon to say with any surety. A move above $25 would be bearish for the broad market and could take the fear index up to the $30 level.

Nine of ten S&P sectors were lower in today's session. The one posting gains was the utilities. The Utilities Sector SPDR was able to make strong move upward, gaining nearly 1% from the short term moving average and moving up from previously broken resistance now turned support. The reason for the move is complex but includes the fact that these companies have little to no exposure to Brexit fall-out, will continue to produce revenue and earnings in the face of a market downturn and pay a dividend, 3.19% for the XLU itself. The indicators are weakly bearish at this time but rolling over into a possible bullish signal. Today's close was a new all time high, if we see follow through it could lead to more new highs with a possible upside target of $52.50 in the near to short term.

The Indices

The indices fell again today. The move was strong, it tried to bounce from an intraday bottom but was not able to recover more than a token amount by the close. The day's leader was the Dow Jones Transportation Average which lost more than -3% and is fast approaching key support levels. Today's move created the second of two long black candles and extended the fall from the 150 day moving average and the 7,500 support level which was broken on Friday. Both indicators are bearish and moving lower, pointing to test of the next support level at least, near 7,000. There is some sign that support exists at this level, today's bounce began just above it, but there is no guarantee it will hold. A move below this level, the first and weaker of two potentially key levels of support, could take it down to 6,750 or 6,500 in the near to short term.

The next largest decline in today's session was posted by the NASDAQ Composite. The tech heavy index fell slightly more than -2.41% in a move that broke below the 4,650 support target and set a near 4 moth low. The indicators are both bearish, showing some strength and pointing to a test of stronger support. Next target for support is near 4,550 with a possible move down to 4,375.

The third largest decline in today's session was posted by the S&P 500. The broad market fell -1.81% at the close, after falling more than -2% intraday, and broke below the 2,020 support target. The index appears to be moving lower and this is supported by the indicators. Both MACD and stochastic are moving lower, confirming the move, stochastic is making a bearish crossover with today's action adding strength to the signal. The index is likely to fall to the 1980 level at least, with additional targets near 1,960 and 1,950, the long term up-trend line.

The smallest decline was posted by the Dow Jones Industrial Average, -1.5%. The blue chips extended their drop below the 150 day moving average and broke below an up trend line with today's move. The index looks set to move lower, perhaps as low as 16,500, and this is confirmed by the indicators. Both MACD and stochastic are pointing lower, and both are showing some signs of strength. One sign is increasing bearish MACD histogram, another is the bearish crossover on the stochastic which completes a strong bearish signal for that indicator.

I've been waiting for a correction for the last 2 months and it has begun. I thought it would be due to poor earnings, not the Brexit, but in the end the Brexit vote was merely the spark that started the selling. I still think poor earnings, declining outlook and tepid economics are why the market is correcting. Now that it has begun the question is, how deep will it run? The transports are already down more than -12% from the peak set two months ago, the NASDAQ about -8%, the SPX about -5.6% and the Industrials about -4.7%. If the transports are leading we could see another -5% or more in the broad market before it is all said and done.

Looking forward I am still positive on the future. Earnings growth is still expected to return, economic expansion is still progressing if slowly and the consumer is getting stronger. This correction is, in my opinion, another hiccup in the long term secular bull market and will provide another great entry for long term positions. I'm bearish in the near term, waiting for signs of the bottom and the start of the next major rally.

Until then, remember the trend!

Thomas Hughes



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