Over the last two weeks, the Dow has lost a total of 84 points and remains just over critical support at 18,400.

Weekly Statistics

Friday Statistics

On the surface, the market appears to be bullish. The S&P closed -2 points from its historic high and the Nasdaq closed 2 points over strong resistance at 5,160. However, the Dow, S&P, NYSE Composite and the Dow Transports all lost ground for the week. The declines were not dramatic and overall we still have a positive market but the cracks are starting to show ahead of the normal seasonal weakness in August and September.

The economic reports did not help on Friday. The Q2-GDP at 1.22% came in at less than half the expected rate of 2.6%. Even worse, the Q1 GDP was revised lower from 1.07% to 0.83% and the Q4 GDP was revised down from 1.39% to 0.87%. That means the economy has grown at an average rate of only 0.97% over the last three quarters and only 1.23% over the last year.

Consumption was the main driver of the Q2 release at 2.83% followed by exports at +0.23%. Fixed investment reduced GDP by -0.52%, inventories -1.16% and government -0.16%. The PCE index showed inflation of 1.9% in Q2, up from 0.3% in Q1. With GDP averaging 0.97% over the last three quarters and inflation spiking from 0.3% to 1.9%, that is the textbook definition of "stagflation."

The only positive for the market from this GDP report is that the Fed is not going to be hiking rates in September or December. According to the CME, the chance of a September hike has fallen to 12%, November 12% and December 33% but those numbers are likely to drift lower next week.

The strong dollar has hampered exports and weak oil prices have reduced the purchasing power for more than a dozen normally high spending nations. The weak economy in China is hurting exports to Asia. None of these problems are expected to go away soon and they will continue to be a drag on the U.S. economy.

Consumer sentiment improved only slightly from the initial reading. The headline number rose from 89.5 to 90.0 but that was still down from the 93.5 in June. This was the lowest level since April. The present conditions component declined from 110.8 to 109.0 and the expectations component declined from 82.4 to 77.8.

Next week we get the payroll data but the numbers would have to be as high as last month before the Fed would come back into the picture. Since June's spike to 287,000 was a correction from May's 38,000 print the odds of a repeat performance over 250,000 are very slim. The consensus view is for a drop back to the 180,000 range and a level that is reasonable for the current economic environment.

The ISM Manufacturing Index on Monday could be a pothole but recent regional reports have shown some strength in spots. Whether this is enough to lift the national ISM is unknown. There is still weakness in some areas and the recent uptick in others could have been transient.

The rest of the economic calendar is busy but the reports are not market movers. One other area that could be a challenge is the Bank of England economic outlook on Thursday. The bank is expected to paint a bleak picture because of the Brexit vote. If the outlook is "gather up the food and the kids and run to the cellar" type of bleak it could be a problem for the U.S. markets. If the report is just a "dang, that was disappointing but we will get through it", bleak then the market will ignore it.

The dollar crashed -1.26% on the GDP news and that rescued the commodity sector from closing lower for the week. The GDP revisions paint a much weaker economic picture and the dollar is the reflection of that picture.

The yield on the ten-year treasury collapsed with a -3.5% drop to 1.458% and a multi-week low. The end of the world trade is coming back into focus with rising fears of a U.S. recession in 2017.

Gold prices rallied off their early week low at $1,315 and back to $1,350 on a flight to quality spike. With inflation rising sharply and economic growth slowing, gold suddenly looks a lot better as an inflation hedge.

Friday's earnings were dominated by the energy giants. Exxon (XOM) posted earnings of 41 cents that missed estimates for 64 cents. Revenue of $57.69 billion missed estimates of $59.83 billion by more than $2 billion. Production fell -0.6% to 3.9 million Boepd. Exxon cut its capital budget by 38% to $5.16 billion but the falling oil prices continued to weigh on earnings. The company only generated a profit of $294 million from the E&P segment. Profits in the refining sector fell by 60% but managed to offset some of the pain from the low oil prices. They will not be able to do that in Q3 because of the glut in refined products and the lack of available storage space. Gasoline prices have declined to $2.14 a gallon as of Friday. That is the cheapest gasoline for this time of year since 2004. Exxon said it will "remain resolute in commitment to pay a reliable and growing dividend."

The $1.7 billion in quarterly profits was still more than most of the S&P-500 stocks will earn but it was Exxon's lowest profit since Q3-1999. The earnings miss by Exxon is a wakeup call for the rest of the sector. If Exxon, the largest U.S. oil company, cannot meet its estimates, the rest of the sector reports could be equally as ugly.

Looking at the Exxon chart, it almost looks like the data was leaked. The sharp decline since last Friday's close at $94 is very unlike Exxon. They normally meet their estimates and there is rarely a sell off ahead of their earnings. Did somebody get the news early?

Chevron (CVX) reported adjusted earnings of 35 cents compared to estimates for 32 cents. Revenue fell from $40.4 billion to $29.3 billion and slightly below estimates for $29.9 billion. Production fell -2.6% to 2.528 million Boepd. Production in the U.S. fell -6% to 682,000 Boepd. The E&P division lost $2.462 billion after a non-cash charge of $2.8 billion for writing down reserves to match current oil prices and writing off projects and investments that may never be developed or completed until oil moves back over $100 a barrel. Some leases may expire before that happens.

Chevron had operating cash flow of $4.5 billion. They spent $5.2 billion on capex and $3.1 billion on their dividend. This represents a funding gap of $3.8 billion. They are making up this shortfall by borrowing money and selling assets. Chevron said "Dividend return to shareholders is our first priority."

Shares dipped to support at $100 and rebounded to close at $102.58 on the dividend promise.

UPS (UPS) reported earnings of $1.43 that were in line with estimates. Revenues rose +3.8% to $14.63 billion and narrowly beat estimates for $14.62 billion. Overall package volumes rose 2.5% with a rise of 2.4% in ground shipments and 5.6% gain in Next Day Air services. Thank you Amazon Prime. Export shipments rose 3.9% thanks to growth in Asia and Europe. The company bought back 13.3 million shares for $1.3 billion in the quarter. Shares declined slightly on the lukewarm earnings.

Dow component Merck (MRK) reported earnings of 93 cents that beat estimates by a penny. Revenue rose 1% to $9.84 billion. Prescription drug sales rose 2% to $8.7 billion. Only a couple of drugs rose but quite a few declined in sales. Their new Hep-C drug Zepatier had sales of $112 million compared to billions for Gilead's Harvoni and Sovaldi. The melanoma drug Keytruda had sales of $314 million and three times the year ago quarter but Bristol Myers reported $1.1 billion for their competitor drugs Opdivo and Yervoy. The company is reportedly looking for acquisitions to build up its pipeline of new drugs to offset the number of drugs it has going off patent and will face generic competition. Shares gained only fractionally.

AbbVie (ABBV) reported earnings of $1.26 that rose 16.7% and beat estimates for $1.20. Revenue rose 17.5% to $6.43 billion and beat estimates for $6.24 billion. Humira sales rose 17.4% to $4.1 billion. U.S. sales of the drug rose 26.7% to $2.7 billion. The company is expanding the uses for the drug into rheumatology, dermatology and gastroenterology. Duodopa sales rose 31.2% and Creon +12.9%. Hep-C drug Viekira sales were $414 million and flat with Q1. With Gilead offering 3 Hep-C drugs and Merck also competing, it is tough to get any traction in that market.

AbbVie raised full year earnings guidance from $4.62-$4.82 to $4.73-$4.83. Analysts were expecting $4.76. The company has said it will fight to maintain the Humira patent but several other companies are already preparing biosimilars to compete with that product. Shares rallied to a 52-week high.

Anheuser-Busch InBev (BUD) reported earnings of $1.06 that missed estimates for $1.09 and well below the $1.21 in the year ago quarter. Revenue declined -2.2% to $10.806 billion but beat estimates slightly. Revenues for the three leading brands, Budweiser, Corone and Stella Artois, rose 8.4% for the quarter. That was powered by a 13% rise in Corona and 9% in Stella Artois and 6% in Bud.

The company also said it raised its bid for SABMiller to 45 pounds or $59 in a cash and stock deal. The company had to raise it one pound because of the drop in the British currency after Brexit. The board of SABMiller immediately recommended shareholders approve the offer. The offer upgrade came as China officially approved the merger. The two largest shareholders, Altria (MO) and Columbia's Santo Domingo family, both urged approval of the deal. The merged companies would account for 30% of global beer sales.

Lexmark (LXK) shareholders voted 99% in favor of the acquisition by a consortium of investors. Over 70% of the outstanding shares voted and of those shares voted more than 99% were in favor of the acquisition for $40.50 per share in cash. However, shares fell -2% to $36.67 because the company reported a loss of 56 cents on revenue of $862.6 million for the quarter.

Tyco (TYC) reported earnings of 54 cents that beat estimates by a penny. Revenue of $2.449 billion missed estimates for $2.457 billion. The company said it was on track to complete the merger with Johnson Controls (JCI) by September 2nd. Earnings guidance was withdrawn because of Irish and European rules related to the proposed merger. Shares are holding near historic highs ahead of the merger.

Xerox (XRX) reported earnings of 30 cents that beat estimates for 25 cents. Revenue fell -4.5% to $4.39 billion but matched estimates. The company cut 1,300 jobs in the quarter and reduced costs by 6%. They have reduced staffing by 11,800 since the end of December but still employ 131,800. They are on track to reduce costs by $700 million in 2016. They have announced a split into two companies. One will be the copier business and the other the services business. The company guided for earnings of 26-28 cents in the current quarter and analysts were expecting 28 cents.

The quantity and quality of earnings will decline next week but there are still a few large companies reporting. The only two Dow components for the week will be Pfizer and Procter & Gamble on Tuesday. The most watched earnings will probably be Tesla, Jack in the Box and Priceline. Normally Linkedin would be in that group but since Microsoft is acquiring them their relative importance evaporated.

Factset said the blended S&P earnings for Q2 have improved to a -3.8% decline compared to the expected decline of -5.5% as of June 30th. Blended revenues are actually showing a minor +0.1% increase for the quarter and it would be the first time in six quarters that revenue did not decline.

With 63% of the S&P-500 reporting earnings, 71% have beaten on earnings and 57% on revenue. For Q3, 36 companies have issued negative guidance and 20 companies have issued positive guidance.

During the month of July, analysts reduced earnings estimates for Q3 by -0.7%. That is the smallest reduction since Q2-2014. Over the last four quarters the average decline in estimates has been -2.7%. Over the last 20 quarters the average decline has been -2.3%. So far, Q3 is shaping up to be the smallest earnings decline in 6-quarters at only -0.6% but odds are good the actual earnings will be positive. Earnings typically come in slightly over estimates thanks to big surprises by a few companies.

The trailing 12-month PE is now 19.4 and the forward 12-month PE is 17.0 and the highest since Q4-2014.

Hewlett Packard Enterprise (HPE) spiked 6% intraday on Friday after news broke that a consortium of private equity firms were considering an offer to take the company private. That would have been a $40 billion acquisition. Later in the day, Reuters broke a story that the group only wanted to buy some software assets from HPE and shares declined to only a 3% gain. That is still a record high.

The falling dollar helped rescue oil prices from a possible break under $40. The low for the day was $40.57 right at the start of the regular session. When the dollar imploded on the GDP report, the price of oil rebounded to close at $41.56. That is a temporary reprieve unless the dollar continues to plummet.

The oil glut is continuing and the new glut of refined products led to a rise in crude inventories of 1.7 million barrels in a month when declines should be normal. With a lack of storage space for refined products, the refinery utilization fell from 93.2% to 92.4% for the week and should continue to decline with the summer driving season over in just four short weeks.

The odds are very good prices will dip under $40 before rebounding in October. I would be a buyer of energy stocks when oil dips under $40. That dip could be brief.

Active rigs rose only 1 to 463 but oil rigs rose +3 to 374. Active gas rigs fell -2 to 86 and the lowest level since June 10th. The small number of gas rigs and the slowing production rate has spiked gas prices significantly.

With only 86 active gas rigs in the U.S., gas production in the first five months of 2016 has been 12,000 Bcf. That is a gain of only 194 Bcf over the same period in 2015 at 11,806 Bcf. For reference in 2014 we produced 10,964 Bcf over the same period, which equated to a jump in production of 842 Bcf in 2015 compared to the 194 Bcf this year. Gas injections into storage for winter consumption were only 17 Bcf last week. The average injection for the last six years for the last week of July was 58 Bcf. Shale wells also produce natural gas. With a decline in new wells of almost 5,000 per quarter for the last 6 quarters compared to the 2014 drilling rate, there are more than 30,000 oil wells that were not drilled and therefore are not producing natural gas to offset declining production in older wells. This slowing gas production has lifted prices from a 16-year low in March at $1.61.

The European banking stress test results were released on Friday after the close of the U.S. markets. The results could cause some volatility at the open on Monday.

The stress test results were not as bad as some analysts expected but they were not good. The European Banking Authority (EBA) reported the Common Equity Tier 1 capital (CEIT) ratio for the 51 largest banks in Europe under a severe stress scenario. The CEIT ratio does not have a pass/fail level but anything under 8.0 is considered weak and over that level is considered safe.

The Banca Monte dei Paschi di Siena (BMPS) saw its CEIT ratio fall to -2.23 and a crisis level. However, the bank announced on Friday it had sold 9.2 billion euros ($10.3 billion) in bad loans and received a 5 billion euro investment from a consortium of underwriters. While that did not repair the bank's balance sheet, it was a step in the right direction.

Other results in the "weak" category included:

Austria's Raiffeisen Landesbanken 6.14%
Spain's Banco Popular 7.1%
Italy's Unicredit 7.12%
UK Barclays 7.3%
Ireland's Allied Irish Banks 7.39%
Germany's Commerzbank 7.42%
Bank of Ireland 7.69%
Germany's Deutsche Bank 7.8%
French Societs Generale 8.3%

With more than 1 trillion euros of nonperforming loans across Europe the banking authority is very concerned about the health of the banks if there is a further deterioration in the economy. The loans depress profits and prevent the accumulation of capital to make new loans. If the pace of bad loans increases in an economic decline the problem will only get worse.

Because the majority of the banks were over the 8% CEIT level the market could celebrate on Monday. There were quite a few analysts preaching doom and gloom that did not come to pass.


Friday was the end of the month and the $600 million in buy on close orders on the NYSE could have been month end buying rather than bets that the market is going to continue higher. Monday could also see a positive bias from the month end cycle.

The markets have now traded sideways for the last 12 sessions. Eventually this consolidation will end with a breakout or a breakdown. The longer we remain in these tight ranges the stronger the move when it comes. The Dow and S&P have been the tightest but the Dow broke down over the last couple of sessions with post earnings depression causing prior Dow reporters to fade.

On the flip side, the Russell 2000 has exactly the opposite trend with a positive bias. Meanwhile, the S&P has failed to move out of its range and continues to move sideways. The gains by Amazon and Google on Friday helped push it to the upper end of the range but that may be temporary.

Fortunately, with the super tight range we have a clear decision point on a breakout or breakdown. If the S&P moves under 2,160 it would be a signal to close bullish positions. If it were to break over the historic high close at 2,175 it would be a signal the rally has farther to run. I would want to see an increase in volume in either direction before I jumped on for a ride. The path of least resistance is still down.

The level to watch on the Dow is 18,400. The Dow has traded below that level intraday on 3 of the last 4 days and closed at 18,429 thanks to those buy on close orders. The post earnings depression is starting to weigh on the Dow. Only six Dow components have yet to report and only two report next week. Neither of those two are generally market movers. If the market is looking for leadership, it will have to look elsewhere.

PG 8/2
PFE 8/2
DIS 8/9
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CSCO 8/17
WMT 8/18

The Nasdaq is not showing any weakness. The index closed over 5,160 and just under the December high at 5,165. This is the last major resistance before testing the historic high close from last July 20th at 5,218. If the earnings continue to be more positive than negative the Nasdaq has a chance of retesting that high but we should remember what happened last year.

The Nasdaq hit that high on July 20th and was trading 926 points lower (-18%) only 25 days later on August 24th. We say that August and September are seasonally weak and are the two weakest months of the year. There is a good track record of declines but there are sometimes rallies. I reported several weeks ago that the years with rallies in August tend to have blowout gains because investors are betting on the seasonal weakness.

If the majority of traders bet on the seasonal weakness and the market goes up there is a monster short squeeze that can keep on squeezing as traders try to reload their shorts at every pause. Likewise, if everyone is betting on a drop and that drop occurs it can accelerate rapidly as everyone piles on when the trade works out as they expected.

The big earnings beats by Google and Amazon helped to lift the Nasdaq on Friday. Unfortunately, all the major market moving tech stocks have already reported. There are a few big names next week but they do not have the same power as Amazon and Google and the Nasdaq is VERY overextended. It will take a lot of positive headlines to continue pushing it higher.

The chart indicators are not showing any weakness so the index could continue higher on some earnings follow through but eventually there will be a post earnings depression phase.

The small cap Russell 2000 is struggling higher after breaking through the resistance at 1205-1210. The moves have been small but continuous. It is as though the fund managers are continuing to nibble at the small cap sector but they are afraid to put any real money to work over 1,200. The index is a long way from its highs at 1,295 and I would be very surprised if we tested that level over the next several weeks. The 1,200 level has been tested as support and it held so that is the key level to watch for a breakdown.

Analysts and traders continue to say the market is tired. However, Boston Marathon runners are tired by the time they get to mile 20 but the finishers keep plodding along at a fraction of their starting pace. The market may be tired and we may be entering a seasonally weak period but the market will continue going higher as long as fund managers are buying defensively to prevent other funds from outperforming them in the annual competition.

Unfortunately, there is a new fly in our soup. For the prior two weeks, the market volume has been very low in the 5.4-5.6 billion share range on average. For the last three days the average has been 7.2 billion with a 7.42 billion day on Friday. I have been telling you we were not in "distribution" mode because the volume was so light. With the sharp increase in volume, it now looks like we are undergoing some distribution. That is when large holders slowly sell stock into a rally at market highs. They do not dump their shares but dole them out at a constant rate in order not to impact the price. Retail traders just think the rally has slowed and is consolidating when in fact the smart money is calmly liquidating.

We need to be cautious next week. With the peak in Q2 earnings behind us and the seasonally weak months ahead of us, there is a real possibility we could see some negative volatility.

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Random Thoughts

Despite the Nasdaq, Russell and S&P hitting new relative highs the AAII sentiment survey saw bullish sentiment decline again. Bullish sentiment declined -4.2% to 31.3%. Bearish sentiment rose +1.7% to 28.4%. Neutral sentiment rose the most at +2.5% to 40.3%. This survey ends on Wednesday. Investors must be looking at those overextended charts and coming to the same conclusion we are that profit taking cannot be far off.

On the day Facebook reported earnings the IRS served them with a "statutory notice of deficiency" claiming the company owes more taxes for 2010. Earlier in July, the IRS sued Facebook to surrender some documents saying that Facebook accountants had undervalued some assets it transferred to Ireland in 2010. The current notice is only for 2010 but IRS has similar investigations in progress for other years. If the IRS can prove its case, Facebook could be liable for as much as $5 billion in back taxes plus penalties. The company is appealing and said should the IRS win the ruling would have a "material adverse impact" to Facebook finances.

Stupidity has no limits. This weekend, stunt man Luke Aikins is planning on jumping out of a plane at 25,000 feet without a parachute or a wingsuit. He will only be wearing the clothes on his back. He is planning on guiding himself to hit a net. The 42-year old daredevil has been thinking about the stunt for several years. Of his 18,000 jumps, he has had to use his reserve chute 30 times. The net is one-third the size of a football field or 100x100 feet and 20-stories high. They test dropped several 200-pound dummies to test the net and one of them punched right through the net. That means he has to not only hit the net but also hit it flat to spread his weight over a wide area. He will be going 120 mph when he hits the net. Good luck Luke!

Do not plan on taking any trips to Jupiter. Recent tests showed that the upper atmosphere is about 620 degrees Fahrenheit and significantly hotter than it should be that far away from the sun. Jupiter is five times farther from the sun than earth. The great red spot is a storm that has been raging for at least 150 years and the advent of modern telescopes. However, some observers have reported seeing the red spot as far back as the 1600s. The spot is twice the size of the earth and winds are blowing over 400 mph. The NASA Infrared Telescope shows the temperature in the clouds above the red spot is 2,420 degrees and the warmest spot on the planet. They believe there are sound waves in the storm that are heating up the atmosphere but until the new probe is operational, they are just guessing.


Enter passively and exit aggressively!

Jim Brown

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