Investors resisted the urge to close positions ahead of the weekend event risk and the Dow even made a new high.

Weekly Statistics

Friday Statistics

I was impressed with the relative strength of the markets on Friday. They should have declined into the close because of option expiration pressures and weekend event risk. I am sure some investors were rethinking their actions when news broke of the potential coup in Turkey. The S&P futures dove -10 points after the close but that should be erased before the open on Monday. Turkey has seen military coups in 1960, 1971, 1980 and 1997. Whenever the "elected" government, and I use that term loosely, strays too far from a secular democracy the military uses force to evict that government and start over again. This coup failed and a lot of people got hurt. At least 161 died, 1,440 were injured and 2,839 military officers have been arrested. Analysts believe this will push Turkey farther into a dictatorship.

Friday saw a very calm market. The Asian markets were slightly positive and the European markets were slightly negative. Nobody was trading ahead of the summer weekend.

China released their Q2 GDP at 6.7% that narrowly beat estimates of 6.6% growth. Another round of government and monetary stimulus kept the economy from sliding lower. Very few people believe the Chinese economic numbers and that was one reason there was not a large market move after the release.

IHS Global Insight said the number will fuel further doubts over the quality of Chinese numbers. "The first misgiving reflects concerns that the government is squeezing as much growth as plausible from relatively opaque sectors via accounting techniques." This was the first release since China said it was changing the way it calculated GDP.

In the USA, the Retail sales for June came in at a healthy +0.6% compared to estimates for +0.1%. However, May's +0.5% number was revised lower to +0.2%. Building materials was the standout with a +3.9% gain followed by gas stations at +1.2%, sporting goods +0.8% and nonstore retailers at +1.1%. Laggards were clothing with a -1.0% drop, electronics and appliances flat at zero, furniture +0.5%, food +0.5% and general merchandise +0.4%. Restaurants and bars declined -0.3%.

Overall sales were up +2.7% compared to June 2015 and +2.2% for May after the downward revision.

The NY Empire Manufacturing Survey for July came in at 0.6 compared to 6.0 in June. New orders fell from 10.9 to -1.8 and backorders fell from -10.2 to -12.1. Employment declined from zero to -4.4. Analysts blamed the headline weakness on Brexit and the uncertainty over orders from the UK. Manufacturers do not know if their overseas business will remain the same or decline as the new Brexit rules are determined.

The Consumer Price Index for June was 0.2% compared to 0.2% in May. Analyst estimates were for a 0.3% gain. Internally food prices declined -0.1% while energy prices rose +1.3% ahead of the July 4th driving weekend. The core CPI, excluding food and energy, rose +0.2% for the third consecutive month. Goods prices declined -0.2% while services prices rose +0.3% for the third consecutive month suggesting rising wages were pushing prices higher for services.

On a trailing 12 month basis the headline CPI is up +1.1% and core CPI is up +2.2%. Medical care costs rose +1.1% while prescription drugs rose +1.3%. Used vehicle prices fell -1.1%. Airfares rose +1.6% after falling -1.5% the prior month. Analysts expect prices to rise +1.6% for all of 2016 and less than the Fed's target of 2%.

June Industrial Production rose +0.6% compared to estimates for +0.2% and a -0.4% reading in May. The majority of the gain came from motor vehicles and parts rising +5.9% after a -4.3% decline the prior month. The second biggest factor was a 2.4% surge in utility production as warm weather caused people to turn on the air conditioning. High tech equipment fell -0.3% and nondurable goods fell -0.1%. Business equipment rose +0.7% and mining (energy) rose +0.2% for the second monthly gain suggesting the oil patch is slowly going back to work.

Business Inventories rose +0.16% in May and slightly better than the +0.14% in April. This is the third consecutive month of gains. Retail inventories rose 0.29% and wholesale inventories +0.13%. The inventory to sales ratio was flat with April at 1.40.

July Consumer Sentiment fell sharply from 93.5 to 89.5 and a three-month low. The present conditions component fell from 110.8 to 108.7. The expectations component declined from 82.4 to 77.1 and the lowest level since September 2014. This is the widest gap between current conditions and expectations since 2006. This is likely related to election expectations. Voters from both parties are severely depressed about the current candidates. Those respondents expecting economic conditions to worsen over the next 12 months increased from 36% to 46%. That is a huge increase and survey respondents are your normal working class person and not specifically interested in economics. With those expecting conditions to worsen nearing 50% they could actually cause weaker conditions because they will be conserving money for the proverbial rainy day rather than spending it and supporting the economy.

We have a small list of events for next week. The most important is the Philly Fed Manufacturing Survey on Thursday. That could set the tone for the ISM and the rest of the regional reports for the coming month. The home construction and sales reports will also be important but they are expected to be flat to weaker than the prior month.

The recent economic reports have actually been improving. It is not an economic surge but they are improving. This suggests there may be some green shoots forming but they are still fragile and not ready for direct sunlight. There are a still a lot of other economics that will weigh on the USA. China may not be reporting economic declines but the country if still weak. Europe is going to be weak for the next year but there are signs there will be additional stimulus in the months ahead. Japan is still circling the drain but they are determined to create enough buoyancy with monetary stimulus even if they have to hire Ben Bernanke to run the printing presses.

Investors appear to believe the current situation is improving. The yield on the ten-year treasury rose from 1.33% the prior week to 1.59% at Friday's close. Those .26 basis points were a huge move.

Gold sold off hard and is down sharply from the $1,377 high to $1,337 on Friday. The flight to safety trade has faded thanks to a rebound in the British pound.

The dollar has slowed its ascent and appears to be struggling to move over the 96.50 range on the Dollar Index. If the dollar would firm at this level until the Brexit fears subside, U.S. companies could hedge against the risk and the earnings outlook may not be that bad.

The British pound was up sharply on the new Prime Minister Theresa May. The relief rally lifted the pound from 126 to 130.50 but it was a shaky rebound. There are still sellers on every uptick but most of the gains are holding.

The earnings cycle is just getting started with 7% of the S&P-500 already reported. The blended earnings decline stands at -5.5% and 66% have beaten on earnings and 51% have beaten on revenue. Revenue has declined -0.6%. Currency issues were mentioned in 21 of the 30 companies that held a conference call. Concerns over Brexit were mentioned in 10 of the calls. According to FactSet no companies have mentioned an impact from Zika or terrorism during their calls.

With the S&P at a historic high at 2,163 the trailing 12-month PE is at 19.4 with earnings estimates at $111.36 and the highest point since February 2010 when the S&P was 1,075 and earnings were $48.11.

In the coming week, 140 S&P companies and 11 Dow components are scheduled to report earnings.

Netflix and IBM will be the headliners on Monday followed by Goldman Sachs, Microsoft and Johnson & Johnson on Tuesday.

The banks have reported decent earnings considering the low interest rate environment and the amount of regulation they have to endure. However, Wells Fargo (WFC) was a disappointment. The bank reported earnings of $1.01 that matched analyst estimates but was lower than the $1.03 reported in the year ago quarter. Revenue of $22.2 billion was also in line with estimates. Net income of $5.56 billion was slightly less than the $5.72 billion in the same quarter last year. The CFO said they had reported more than $5 billion in earnings for 14 consecutive quarters. That is a decent record in this low rate environment. Total loans rose +8% to $957.2 billion.

The bank's net interest income rose 4% to $11.73 billion but the net interest margin fell to 2.86%. Mortgage loan originations rose +43% from the prior quarter and +2% from Q2-2015.

Wells said their loan charge-off rate rose from 0.16% to 0.29% primarily because of oil and gas loans. Shares declined -2.5% on the earnings news.

Citigroup (C) reported only a 14% decline in earnings compared to the 25% predicted by the CEO in early June. They credited the surge in trading for currencies and bonds in the wake of Brexit for the better performance. The bank reported earnings of $1.24 that beat estimates for $1.10 but it was well below the $1.45 earned in the comparison quarter. Their net interest margin declined from 2.95% to 2.86% and they predicted a return to 2.9% later in the year. Shares were flat after rising for the last week in advance of earnings.

US Bank (USB) reported earnings of 83 cents that beat estimates for 81 cents. That also beat the comparison quarter of 80 cents. Net revenue rose 8.1% to $5.4 billion and beat estimates for $5.2 billion. Net interest income rose 4.5% to $2.9 billion. Net interest margin of 3.02% beat the other banks and only declined -0.01% from the prior year. Noninterest income spiked 12.3% to $2.6 billion. That is a lot of overdraft and NSF charges. Total loans increased 8.1% to $266.6 billion thanks to a rise in commercial loans. Deposits rose 7.6% to $307.4 billion. USB shares actually rose on the earnings.

Herbalife (HLF) dealt Bill Ackman an expensive blow on Friday when it announced a settlement with the FTC for $200 million. The billionaire hedge fund manager has a $1 billion short on Herbalife and intraday spike to $70 and a two-year high was very painful. However, Ackman may eventually be right. The FTC said HLF had to operate "legitimately" from now on and that suggests they were not doing so in the past. Herbalife said it disagreed with many of the FTC allegations but decided to settle so they could put the problem behind them. They also agreed to pay $3 million to settle an investigation by the Illinois attorney general's office. Herbalife has now resolved all active investigations.

The problem for Herbalife is the agreement to restructure the compensation plan so that at least two-thirds of compensation for distributors is paid on the actual sale of the products, not recruiting. Also, the company must prove that 80% of future sales are to legitimate end-users or compensation must be reduced. The change in compensation will be a major change for Herbalife. The plan will change completely to a sales based plan rather than a recruitment plan.

The settlement only applies to the U.S. but other countries are not stupid. They will likely review compensation structures in their country and demand changes as well to protect their citizens from overzealous recruiters.

Without the recruiting bonuses, current distributors are likely to dry up and drop out. This is where Ackman could still be right. Earnings are likely to plunge over the next year and the stock should follow. I looked at buying a LEAP put on HLF but the prices are enormous. Maybe in a few weeks the volatility will subside.

On a side note, Carl Icahn owns about 18.3% of Herbalife stock and he was just granted an exemption to raise that stake to 34.9%. Icahn took the position after Ackman went public with his big short and some said he did it just to get back at Ackman for a prior conflict. There is some discussion that HLF might go private but I think that is smoke. With the uncertainty over future earnings, it would be tough to convince any PE firm to put up the money until there is actually a track record. I seriously doubt Icahn will increase his stake for that very reason. The next thing we hear from Icahn is that he liquidated his position for a tidy profit since he got involved in the $30s and $40s and the stock is $65 today.

Shares spiked to $72 at the open and faded to close at $65 for a $6 gain. I would not be surprised to see it back under $60 very quickly. Volume on Friday was 35.3 million with only 93 million shares outstanding. Average daily volume is only 1.3 million shares. That was 27 times normal volume. A lot of shorts following Ackman were crushed in the spike.

AMC Networks (AMCX) was downgraded by UBS to sell on worries the ratings on it most popular shows are falling. The hit series The Walking Dead is seeing ratings decline sharply after 6 years. You can only kill so many zombies and kill off so many regular cast members before viewers start looking for other shows to watch. The new spinoff called Fear The Walking Dead is already being called a flop and viewers have been declining steadily since 10 million watched the premier in August 2015. The Better Call Saul series has been seeing double-digit ratings declines. UBS said they do not see any near term catalysts to resolve these concerns. They are also worried AMC will be shut out of the new online pay TV service offered by Hulu next year. UBS also cut CBS and Discovery Communications to sell as well.

Yahoo (YHOO) will report earnings on Monday but that will be just a prelude to the real show. Reportedly, Monday is the deadline for the final bids on buying the company and its various assets. Estimates range from $3 billion to $6 billion depending on which assets the buyer is willing to take. The deal will be very complicated and actually getting a deal accepted and closed will be very difficult.

Earnings are expected to be 10 cents compared to 16 cents in the year ago quarter. The whisper numbers are in the 8-9 cent range. As part of their sale process, they have been forced to disclose agreements that were not previously public. For instance, Yahoo has a contract with Mozilla (Firefox) that costs Yahoo $375 million a year for five years. It expires at the end of 2019. For that fee, Firefox defaults to Yahoo search in that browser. That means any buyer is on the hook for more than $1.2 billion in fees to Mozilla the day the deal closes. The bad news is that Firefox users and usage shares have been in a steep decline. Google's Chrome browser and Microsoft's new Edge browser are stealing users from Firefox and Opera at a rapid rate. Since the deal was signed in 2014, Firefox share of the browser market has fallen 21%.

Last week Yahoo further complicated its revenue prospects when they implemented a new site. That has been the number one stock news research site for the last 15 years. Now it is practically unusable with bloatware and more ads than news. The investor community is very upset. Yahoo was getting so many complaints they had to deactivate their message boards and complaint links.

I am really tempted to buy a 35/40 August strangle, currently $1.33, on Yahoo on Monday before earnings.

Oil prices rebounded slightly on Friday but glut fears are growing. SocGen, BNP Paribas, UBS and JBC Energy all warned of the risk of another decline in prices. They believe $40 is the floor that will trigger buying again. The IEA warned "the road ahead is far from smooth." Inventory storage is at maximum capacity and production is still flowing. There are more tankers at sea with floating storage than any time since 2009. There were significant supply disruptions early in the summer and most of those have been resolved. With production back in a surplus over demand we are running out of places to store the oil.

Gasoline inventories are at "epic" levels according to Energy Aspects Ltd, an energy consultancy. At least five tankers hauling gasoline to New York were turned away over the last several weeks due to lack of storage. The IEA said stockpiles are at all time seasonal highs. Refiners running out of room to store oil refined it into gasoline they could ship anywhere in the world. Unfortunately, some of those tankers are now anchored because there is nowhere to store it.

China added to the problem after extreme weather damaged roads and pipelines in the country and killed domestic consumption of fuel. Instead of shutting down their refineries, they tried to export all their surplus production. Normally Chinese gasoline exports begin to fall in March. This year they were still rising through May. In May, exports were more than double the five-year average.

This means oil prices are likely to fall and gasoline prices are already falling. The national average was $2.22 on Thursday after a 7% decline over the last month.

Active oil rigs rose +6 last week bringing the total gain to 27 over the last three weeks. Offshore rigs rose 3 to 22 for the first gain in more than two months. Gas rigs rose +1 to 89 but they have been in the 85-90 range for months. There is no growth in active gas rigs.


The S&P surged +32 points last week and narrowly missed setting a new closing high for all five days of the week. That has not happened since 1998. The S&P closed down -2 points on Friday to prevent that from happening.

The S&P is now more than 30 points above its prior high from May 2015 at 2,130. The weekly chart is highly bullish and the lack of a material decline on Friday ahead of the weekend event risk suggests buyers are not going to slack off next week.

The MACD and RSI are bullish and there is no immediate resistance to slow the advance as long as the headlines are favorable. The earnings cycle kicks into high gear and I am not sure even weak earnings and guidance could be a significant drag.

When there is no alternative to equities for a return of more than 2%, we may be seeing the start of the great rotation out of treasuries and bonds. Treasury yields spiked all week indicating selling and equities rallied all week.

Technicians claim 2,061 and 2,071 are the current resistance levels and the S&P stopped on 2,061 on Friday.

The Volatility Index is back in the mid 12 range and showing complete complacency. Nobody expects this rally to fail or at least they are not buying puts for insurance against a potential decline.

When rallies appear when they are least expected they have a tendency to continue longer than normal. Traders in denial will continue to short any weakness and portfolio managers will continue to chase prices to avoid being left behind in an extremely competitive industry.

The Turkey coup attempt should not weigh on the market but it could cause some volatility at the open on Monday.

The Dow chart is a duplicate of the S&P with the index stopping just over tentative resistance at 18,500. The MACD and RSI are strongly positive and could run for another week before hitting the top of their normal ranges.

If we were to get a couple days of serious profit taking I would expect prior resistance at 18,000-18,100 to be support and a second rebound could be equally as strong as the first because everyone would back up the truck on a dip.

There are 11 Dow components reporting earnings next week and it is possible they could spoil the party but the earnings and guidance would have to be really bad and I do not see that happening. Multinational companies are going to warn on currency issues but that is already baked into the market cake. After the first few warnings next week, that excuse will be ignored for the rest of the earnings cycle. "Brexit ate my earnings" is going to be a familiar refrain.

The Nasdaq Composite is the index laggard. The Composite only gained 1.47% and the Nasdaq 100 gained 1.36% to post the smallest gains of the major indexes. The Nasdaq did punch through the resistance at 4925-4950 to close at 5,029 but the next 200 points could be difficult. There is significant resistance between 5100-5225 that the index has to cross before it can make a new high.

With the biotech sector posting alternating gains and losses and portions of the chip sector weak on worries over Apple's production cuts, the Nasdaq is not keeping pace with the rest of the market.

There are some heavyweight techs reporting next week and the volatility could be huge. IBM, NFLX, MSFT, FFIV, EBAY, INTC, QCOM, PYPL and BIIB are just a few. If most of those names were to beat on earnings and give decent guidance it would be an entirely different market by next weekend. Conversely, if they really stink up the place it could kill the current rally.

The Russell 2000 gained +2.37% last week to lead the winners list of the major indexes. This is very positive since a surge in small cap buying suggests portfolio managers are not afraid of future volatility and that is good for market sentiment. However, the Russell did stop right on strong resistance at 1,205 and nearly 100 points from a new high at 1,295.79. That would be a very nice run if it happened. If the Russell were to make a new high, the broader market would be sprinting towards 2,250 or higher.

Remember, traders are always fixated on new highs. Once they are hit the market normally loses traction while a new target is discussed and profits are taken and then the market moves higher. So far, this has not happened in this rally. New highs tend to beget new highs. If Friday's fractional losses on the indexes are all we are going to get, then buckle your seatbelts.

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Random Thoughts

Bullish sentiment surged 5.8% to 36.9% in the AAII Sentiment Survey that ended on Wednesday. That is the highest level since March 9th at 37.4%. Neutral sentiment declined -3.6% to 38.7% and the 24th consecutive week over its historical average of 31%. Bearish sentiment fell -2.2% to 24.4% and the lowest level since April 20th at 23.9%.

Bullish sentiment hit a low of 22.0% on June 22nd and has rebounded 14.9% but remains under the historical average at 38.5%. Investor comments were generally bullish and Brexit has been forgotten.

Bank of America Merrill Lynch said investors poured more money into the market through equity funds than any week in the last nine months. More than $10.8 billion flowed into funds in the week ended on July 13th. That ended the streak of 17 consecutive weeks of outflows. Next week could be even stronger now that the market is making new highs. European equity funds saw outflows of $5.8 billion and the 23rd consecutive week of outflows.

Bond funds also saw inflows. A record $2.1 billion flowed into high-yield bond funds on Monday. That was a historic record and led to a total of $4.4 billion for the week. Investment grade funds saw inflows of $1.8 billion and the 19th consecutive week of inflows.

BAML said investors were "stampeding" into equity funds on fears of missing out on a continued rally. BAML called it "Bear Capitulation."

The same bank that reported those fund flows above also believes the markets could decline up to 15% this summer. Savita Subramanian, head of U.S. equity and quantitative strategy for BAML Global Research, said on Wednesday the S&P could test its lows near 1,800. That would have been more than 16% below Friday's close. She cited valuation, seasonal weakness and uncertainties surrounding the election and Brexit negotiations in Europe. Also, another leg down in oil prices could drive the market lower.

Subramanian reiterated her yearend target of 2,000 for the S&P. She lowered that target from 2,200 on February 12th. She recommended owning volatility during election years. She said the VIX normally spikes to 24 in the month before the election. She said the uncertain impact of a Trump presidency could create a more hawkish Fed and put a cap on PE multiples for the S&P.

Another BAML strategist, Stephen Suttmeier, Chief Equity Technical Strategist, said it took more than 300 days for the S&P to make a new high. That is a relatively rare occurrence that historically tends to send the index significantly higher as buyers overcompensate on the breakout. There were 414 days between the May 2015 high and the recent new high. Since 1929 there have been 24 instances when the market went more than 300 days. Historically, 250 days from the breakout the average return is about 15.6% according to Suttmeier. The median return is 14.8% and the market rose 91% of the time. He also noted that market breadth was increasing rapidly along with new 52-week highs.

Friday's volume was only 6.02 billion shares are slightly stronger than a normal summer Friday. Advancers and decliners were almost dead even. Since Friday was technically a down day the low volume is a plus. We have been seeing higher volume on the days when the market is advancing. That is a definite change in trend.


Enter passively and exit aggressively!

Jim Brown

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