A combination of factors helped lift the Dow 940 points in four days but resistance remains strong and sellers were waiting.

Weekly Statistics

Friday Statistics

Traders used Friday as a consolidation day. Nearly every stock that was up big over the prior three days saw some profit taking. However, it was light and there was not a herd of bulls stampeding to the exits. I think investors are unsure of what the next week will bring but most were willing to wait and see rather than taking their chips off the table.

The Dow hit 18,000 and came to an abrupt halt. The S&P traded as high as 2,108 before sellers overpowered buyers and pushed the index back to 2,103 at the close. The Nasdaq touched resistance at 4,880 before giving up 18 points to close at 4,862. All the material resistance levels held in a low volume environment.

The factors that helped lift the market from the lows have ended. Equity funds used some of their near record cash hoard to window dress their portfolios for the end of the quarter. Pension funds spent as much as $18 billion to bring their bond/equity ratios back into balance. Bargain hunters bought the dip but now there are only a few bargains left after the big rebound. With the Brexit uncertainty still a cloud over the markets, we will need a new headline to power us higher next week.

The ISM Manufacturing Index for June surprised at 53.2 compared to 51.3 in May and estimates for 51.4. After several declines in the regional reports there was a risk the national ISM would miss estimates. Instead of a miss, that was the highest reading since the 53.5 in June-2015. After spending five months (Oct-Feb) in contraction territory, the index has surged and is showing some strength. Unfortunately, the sharp drop in the pound and spike in the dollar is likely to create some headwinds in the months ahead.

The production component rose from 52.6 to 54.7, new orders 55.7 to 57.0 and order backlogs from 47.0 to 52.5. Employment actually edged back into expansion from 49.2 to 50.4. Export orders rose slightly from 52.5 to 53.5. Twelve industries reported manufacturing growth and five reported a decline. Those declining included wood products, electrical equipment, primary metals, plastics/rubber and transportation equipment.

Construction spending improved slightly for May from a decline of -1.8% in April to a decline of -0.8%. Analysts were expecting a rise of +0.6%. Total construction spending in May was $1.14 trillion.

Vehicle sales for June fell to an annualized pace of 16.66 million compared to 17.45 million in May. The trailing 12-month average was 17.5 million so the decline was significant. Auto sales declined from 7.1 million to 6.8 million. Light truck sales declined from 10.3 million to 9.9 million. Truck sales were helped by the continued low gasoline prices and low interest rates. Consumers are saving an average of $183.5 million per day on lower fuel prices over the same period in 2015.

The flight to quality and search for yield is continuing with the yield on the ten-year treasury falling to 1.456% at the close after a 1.414% intraday low. Those are four year lows and very close to a historic low at 1.394%. The yield on the 30-year treasury hit 2.205% intraday, which was a historic low. The record close at 2.241% is just below the prior record low close of 2.251% in January 2015. These yields reflect the movement of cash from overseas in search of yield and safety. More than $13 trillion in overseas government bonds are now trading at a negative interest rate. You have to pay the government to hold your money.

This is one of the few things that could lift the equity markets next week. Investors looking for a return greater than those government bonds may be forced to look at high yield bonds or equities.

This is payroll week with the ADP Employment on Thursday and the Nonfarm Payrolls on Friday. The consensus estimate on the ADP is 150,000, down from 173,000 jobs reported for May. The consensus range was 100,000 to 209,000. The consensus estimate for the Nonfarm report is 180,000, significantly higher than the 38,000 actually reported for May. The consensus range is 130,000 to 235,000 so a diverse group of opinions. After the Brexit vote, the job numbers no longer matter to the Fed. There is almost no way they could hike in July so the jobs are just a data point for later in the year.

The FOMC minutes for the June meeting will be released on Wednesday and after the sudden change in direction for the majority of Fed members, this report will be scrutinized even harder than prior reports to try and determine what happened.

In stock news Tesla ($TSLA) shares recovered from a sharp drop in afterhours trading on Thursday when the NHTSA said it was investigating a fatality that occurred in a Model S while being controlled by the autopilot. Tesla said that was the first fatality in more than 130 million miles.

The car was traveling at a high rate of speed and a truck and trailer coming from the other direction turned in front of the Model S. The car did not brake because the autopilot did not differentiate between the sudden appearance of the white trailer and the very bright sky. The car went under the trailer and sheared the roof completely off the car. The Model S continued down the road another half mile before hitting a telephone pole and snapping the pole in half.

The driver was a strong supporter of Tesla and bragged about using all the technological features of the car to their limits. When bystanders approached the car there was a DVD player still playing a Harry Potter movie so apparently the driver was not paying attention to the road.

Tesla and Mobileye (MBLY), the maker of the Autopilot software, were quick to remind everyone this is not a self-driving car. The Autopilot is designed for keeping you in your lane, changing lanes, etc. It is more of a cruise control on steroids and not a self-driving system.

Tesla shares fell to $205 from a close at $212 in afterhours when the initial news was released. After the full details became public, shares rebounded to close at $216 on Friday.

Micron (MU) reported an adjusted loss of 8 cents that beat estimates for an 11-cent loss. Revenue of $2.9 billion fell -24.8% and missed estimates for $2.95 billion. The company lowered guidance and said it would slash 2,400 jobs as part of a cost-cutting plan to combat challenging market conditions. The company said demand for DRAM chips used in PCs continued to fall and the market for NAND chips used in devices like Smartphones was becoming very competitive. Revenue has declined for three consecutive quarters. Now the company said it would focus on fewer products and try to streamline operations for that smaller product base. Current quarter revenue is expected to decline from 11% to 19%. Shares fell -9% on the weak guidance.

Oracle (ORCL) shares were up fractionally despite a jury award of $3 billion in damages to HP Enterprise (HPE) for breaking a contract back in 2011. The company contracted to support HP's Itanium servers and then changed its mind after CEO Mark Hurd was booted from HP and hired by Oracle. A five-week jury trial found the contract to be valid and awarded the $3 billion to HPE. Oracle said it would appeal and I am sure they will appeal it through every court available rather than pay those damages. They can spend several million a year in attorney's fees and they might get lucky several years from now and have a higher court overturn the judgment.

Disney (DIS) is in talks to acquire a one-third stake in the technology services unit of MLB Advanced Media, known as BAM Tech. This values the company at roughly $3.5 billion. Disney would also get a four-year option to buy another 33%. The streaming service is very popular with consumers. The service streams live broadcasts of out-of-market games. MLB had about 3.5 million subscribers at the end of last season.

Disney is riding the wave of record setting revenue from the Finding Dory movie and The Big Friendly Giant (BFG) starts this weekend. This could be another strong movie with its production budget of $140 million.

Hershey's (HSY) board unanimously rejected the $23 billion acquisition offer from Mondelez (MDLZ). A charitable trust set up by Hershey's founder owns 81% of the company's voting stock. Without the trust approval, a sale is impossible. There have been multiple acquisition attempts in the past and all have failed. In 2002, the Wrigley Company tried to buy it and failed. In 2007, Cadbury also failed. In 2010, the trust prevented Hershey from bidding to buy Cadbury. The trust was set up more than 100 years ago to benefit underprivileged children. However, it is being investigated by the Pennsylvania AG regarding its spending habits and how long its directors serve. The AG's office has called for the resignation of three of the longest serving directors. The trust has created a $12 billion endowment that funds a school and amusement park in Hershey PA.

Mondelez may have thought that the current investigation might have provided a crack in the armor surrounding the trust and made them more agreeable to a sale. However, the AG's office also has veto power of any deal if it deems it "unnecessary for the future economic viability of the company." I would say there were some nearly insurmountable hurdles for a Mondelez deal. That being the case, Hershey could be a huge short opportunity on Tuesday.

Apple (AAPL) may be in talks to buy Jay Z's streaming music service Tidal. The artist bought the service in 2015 for $56 million. Apple is apparently considering the acquisition to enhance its existing Apple Music product. Tidal has quite a few big name artists including the majority of the Prince catalog. Potential competitors for a Tidal deal include Samsung, Google and Spotify. The rumor could not lift Apple shares because of even bigger rumors about the iPhone 7.

There is a growing stack of evidence that the iPhone 7 will be a lackluster offering. Even worse, apparently, Apple is planning on releasing the iPhone 8 in 2017 and skip the model S update cycle for the iPhone 7. The lack of must have features on the 7 according to the dozens of leaks, could fail to excite the buying public.

The WSJ recently revealed "At a meeting with an Apple executive last month, one of the company’s China-based engineers asked why this year's model lacked a major design change in keeping with Apple's usual two-year cycle. The answer, one person at the meeting recalled, was that the new technology in the pipeline will take time to implement. People familiar with the matter said some features that Apple hopes to integrate into iPhones, such as curved screens, weren't ready for this year's models." The iPhone 7 is rumored to be "almost identical" to the 6/6S. With so many leaks about the lack of features on the 7 and radical new features on the 8, the buying public may wait until 2017 and buy the 8. That would be a serious blow to the 7 and to Apple's revenue. There is also a strong recurring rumor of an iPhone Pro in 2017.

Mizuho downgraded Apple suppliers on Friday on worries about smaller orders for components. They downgraded Skyworks (SWKS) from buy to neutral and slashed the price target from $99 to $68. The analyst cut Qorvo from buy to neutral with a price target of $55.

Canaccord Genuity initiated coverage on Netflix ($NFLX) with a buy rating and a price target of $120. The analyst cited the strong viewership of the shows streaming on Netflix. The premier episode of Orange is the New Black was seen by 6.7 million in the U.S. and comparable with the HBO hit Game of Thrones. He said Netflix has a long runway for growth internationally even if Q2 subscriber growth fails to impress. The long-term outlook is very strong after they opened in 130 countries in January.

He said Netflix only has about 5.3% penetration in international markets compared with 37.3% in the USA. In his studies of market penetration he found that by the third year subscribers exceed 10% and by the fifth year it is over 20% on average. Emerging markets take longer than developed markets but the overall trends still apply. Canaccord expects 112 million international subscribers by 2020 compared to 27.4 million today. That rises to 187 million by 2025.

In the map below, the red areas were open in December 2015. The green areas were opened in January 2016. The only area not yet open is China because of their censorship. January was a major growth spurt for Netflix and according to Canaccord they are just scratching the surface. Netflix Growth Forecast

Harley-Davidson (HOG) shares spiked 20% on rumors it had received a bid from private equity firm KKR. The rumor came from "TheFly.com" and neither HOG or KKR would comment on the news. This could be another shorting opportunity.

U.S. Steel (X) rallied 8% on news of very heavy option activity in the calls. More than 12,000 January $24 calls were purchased compared to an open interest of 1,157. That is a long window and the stock was only about $17.50 when they were bought. That is about a $1 million bet.

Another potential short candidate would be Jones Lang LaSalle (JLL). Shares have turned negative after Brexit because they generate 26% of their revenue from Europe and the UK. Research firm Green Street Advisors warned that London office building values could fall as much as 20% within three years as companies move out to find new locations that are still in the EU. New leasing activity is also expected to fade with companies being reluctant to lease new space until after the actual exit and then any new leases could be in EU countries depending on the post exit commerce rules imposed on the UK.

The Q2 earnings cycle does not really take off until the following week. So far, 81 of 113 S&P companies issuing guidance have warned on earnings. That is expected to worsen. That compares to 96 out of 122 warning in Q1. To date only one company has warned because of Brexit and that was Carnival Corp (CCL). Q2 earnings for S&P companies are expected to decline -5.3% compared to the final -6.7% decline in Q1. Historically earnings typically end about 2% above their estimates at the beginning of the quarter. At the start of Q2, earnings were expected to decline -8.8%. This will be the fifth consecutive quarter of earnings declines. Revenues are expected to decline -0.8% for the sixth consecutive quarterly decline.

The tech sector has seen the largest decline in earnings estimates led by Apple with a cut from $1.78 to $1.40 per share. Tech earnings are now expected to decline -7.2%. Overall, 36 of the 72 companies in the S&P tech sector have seen estimate cuts. IBM estimates were cut from $3.44 to $2.88, Microsoft from .67 to .58 and Seagate from .78 to .13 per share.

The energy sector is going to lead the losers list when they report in Q2. Analysts are expecting a 77.7% decline in energy earnings.

The current market PE on a forward basis is 16.4 compared to the 10-year average at 14.3.

Crude Oil

Crude prices have been trading in a range from $46-$50 over the last several weeks as inventory declines have been spotty and the dollar has been increasingly volatile. U.S. inventories declined -4.1 million barrels last week as we head into the busiest driving weekend of the summer. Gasoline demand is expected to hit a record of more than 10 million barrels per day thanks to the low fuel prices. The national average was $2.28 per gallon on Friday. The average for the first six months was $2.04 per gallon and the lowest prices since 2004. Because of the oil glut, gasoline prices are expected to remain between $2.25-$2.40 for the rest of the summer. Gasoline demand could exceed the record demand set back in 2007. U.S. oil production was 8.622 mbpd last week and that is one million bpd lower than the 9.61 mbpd peak on June 5th last year.

Active oil rigs spiked +11 to 341 last week with gas rigs falling -1 to 89. Offshore rigs fell -2 to 19 and a new low for this cycle. This compares to 60 two years ago.

The price of natural gas is exploding higher because of low injections into storage and the falling rig count for gas rigs. With the Cheniere LNG facility in Louisiana ramping up production there is additional demand that was not in the system last year. We added only 42 Bcf to storage last week and we are heading into the high demand cooling season where gas is used to generate electricity.


The last seven trading days have been a lesson in extremes. The Dow declined from the 18,011 close on Thursday before the Brexit results to 17,063 on Monday. That 948-point drop in two days was erased by a rebound to 18,002 intraday on Friday. The S&P fell from 2,113 to 1,991 and returned to 2,108 at the high on Friday.

However, it was the volume that is the most amazing. The market rallied last Thursday on expectations the UK would vote to stay in the EU. The S&P hit a four-week high at 2,113 at the close. However, the volume was anemic at only 6.387 billion shares. For that kind of rally, the volume was very low.

On Friday, the market traded more than 15 billion shares or nearly 2.5 times the volume on Thursday. Complicating an apple to apples comparison was the Russell index rebalance at the close. But the volume was still extreme even without the rebalancing. Monday traded 10.6 billion shares in another huge decline.

The last three days of the quarter saw more than 8 billion shares each thanks to equity fund window dressing, investors bargain hunting and pension funds rebalancing their bond/equity ratios.

If you had any doubt that those factors were impacting the market you only need to look at the volume for Friday and the first day of Q3. It was right back at the 6.7 billion shares we were trading before Brexit happened.

This is what I expect next week. Light volume and choppy markets. Without the funds being forced to put money to work, we may not have any upward momentum. In fact, we could see some window undressing because of the continued uncertainty out of Europe, the strong dollar and the plunging pound.

Make no mistake. We witnessed a rare market event last week that would have had significantly different results if it had occurred a week later on the calendar and the fund moves were not a factor.

The market volatility has collapsed. The VIX hit 26 on Friday but immediately began to decline even while the markets were still falling on Monday. Traders did not expect the Brexit decline to last and the falling VIX was the proof. At Friday's 14.77 close, it is nearly back to the 13 lows from the prior three weeks. There is no fear in the market. The monster rebound has put everyone back into complacency mode.

The S&P climbed right back into the resistance band that has prevented further gains since last summer. We have been here many times and each time has resulted in a failure and a decline. Now that we are in the summer doldrums between July 4th and Labor Day, the volume will be very low and conviction on the part of the bulls will probably be lacking. There are too many factors hanging over the market.

The EU is refusing to negotiate with the UK over their future trade agreements until after they submit the Article 50 request to exit the EU. The UK has said they will not do that until after a new PM is installed in September or even as late as October. Some voices in the EU are recommending harsh penalties on the UK in order to prevent other countries from duplicating their exit. This was always a worry before the Brexit but now it is growing.

The strong dollar, weak pound will cause earnings warnings in the Q2 earnings cycle that starts in two weeks. We can count on it. With earnings already expected to decline more than 5% the outlook is already shaky. U.S. economics are improving slightly but it is spotty, not nationwide. Whether that is enough to energize the bulls remains to be seen.

The key is going to be resistance. If the S&P can make a new high over that 2,119 close back in early June then we could be off to the races. That is a capital "IF" because they have not been able to do that over the last 11 months in a better market environment. While it is possible to continue last week's rally, it is not probable. I hope I am wrong.

Resistance from 2,100 to 2,128 is very strong as we have seen for the last year. The market is now overbought after a 1,000 point and 111 point rebound on the Dow and S&P. That is a huge gain in only four days.

Support remains 2,040 and we can start to get excited with a move over 2,115.

The Dow has the same problem as the S&P with major resistance from 17,925 to 18,165. The dead stop at 18,000 on the last three attempts suggests there are plenty of sellers waiting to exit at that level. The Dow stocks are international and they will see a greater impact from the strong dollar, weak pound/euro combination. I would be very surprised if the majority did not warn on guidance.

For Tuesday, the resistance at 18,000 is key. If the market continues to fail at that level it could sour sentiment and force some more consolidation at a lower level. A decent range has been established between 17,400 and 18,000 and we could spend some more time chopping around in that range.

The Nasdaq Composite had a nice rebound but unlike the other major indexes, it failed to return to the strong resistance at 4,900. It did come close but it also declined more in the afternoon. The Nasdaq has strong resistance at 4,900 and again at 4,968 and that is well below the major resistance from 5110-5160. If the Nasdaq remains the weakest link in the market the other indexes will feel the drag.

The Russell 2000 performed a textbook rebound from support at 1,095 and is now back in the congestive resistance from 1150-1165. This is the same relative level to the Nasdaq rather than the strong performance of the Dow and S&P. The Russell 2000 benefitted from the rebalance the prior Friday as funds continued to add to positions last week to get their weightings right after the reconstitution. That extra lift will be absent next week.

The Russell will not be a plus for the market until it moves over 1,200. With a broad resistance range that is the key level to watch.

Last week I suggested buying a rebound on Monday. That came at 11:AM and again at 3:PM. Both rebounds came from support at 1,990, which I have been showing on my charts for months. If you bought that rebound, you should be a happy camper. If you took Art Cashin's weekend suggestion of buying at 11:AM on Tuesday you would still be a happy camper.

This week I would caution you not to be overly long. The market is short term overbought and sitting right at strong resistance. What headline could produce a continued rally? I do not know of one this weekend. Volume is going to be very light in a holiday week and the markets can either go dormant ahead of the following week's start to earnings or they could be volatile in that light volume. Time will tell.



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Random Thoughts

Bullish sentiment spiked +6.9% to 28.9% for the week ended on Wednesday. The survey ends on Wednesday so there were two days of very strong gains to offset the Fri/Mon drop. Neutral sentiment fell 5.1% to 37.7% and bearish sentiment declined -1.8% to 33.4%. Apparently, the bears were not convinced the rally was going to stick since the majority of change came out of the neutral camp.

The CME FedWatch Tool is predicting a 100% chance of no rate hike at the July meeting. There is actually a 2.4% chance of a rate cut. Obviously, it is way too early to be talking about rate cuts but that is what the Fed funds futures are showing.

The September meeting is showing a 5.9% chance of a rate hike and a 2.2% chance of a rate cut. The biggest increment at 91.9% is showing no change. You can go all the way out to the February meeting and there is only a 22.9% chance of a rate hike.

Your home address is about to change. A new startup is going to change the way we find addresses by shaking up the global addressing system. The U.S. has figured out how to address locations in a somewhat logical way but the rest of the world has not. Finding an address in Latin America or Africa is a tough job. Some 126 countries do not have a countrywide addressing scheme. Global shipping companies are constantly struggling with locations without physical addresses. Finding the "fourth house on the left after the road turns to gravel" or the "third business past the lamp post" is hardly a desirable address. What3Words claims more than 4 billion people are invisible and cannot get mail or deliveries or receive aid because they do not have a valid address.

The startup, What3Words, is planning on fixing that problem. Instead of road names and zip codes, the company has divided the world up into 57 million 3x3 meter squares and assigned each square a three word identifier such as "dog.cat.stick."

Using the company's system, anyone can find any address on the planet by speaking/typing the three words into a smart watch, mobile phone, GPS device or automobile navigation system. Several countries have already signed up to have their country addressing system converted to What3Words. Mongolia's state-owned postal delivery service, Mongol Post, is making the system the national addressing standard. The system is currently in use in more than 170 countries.

The beauty of this system is that the 3x3 meter location can be anywhere. It does not have to be on a road, highway, city, etc. It can be at the bottom of the Grand Canyon or deep in the Amazon rain forest. Like GPS but easier to operate you can find anything or anywhere with just three words. The same capability exists with GPS but the nomenclature is harder to work with. For example the GPS coordinates for the Empire State Building are N40° 44.9064', W073° 59.0735'. In W3W terms, the actual address is "veal.notion.loses." What3Words is not writing their own mapping software but partnering with existing companies like Garmin or Navmi to integrate the three words into their existing systems. The only problem I see in the future is people wanting to assign their own three words to their location like "good.singles.bar" instead of "stinky.dead.snake."


Enter passively and exit aggressively!

Jim Brown

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