It was definitely a summer Friday with volume very low despite the major indexes at historic highs.

Weekly Statistics

Friday Statistics

Friday's volume fell to 5.5 billion shares to round out a very light week that averaged only 5.894 billion shares per day. You would not have known it was a record week on the indexes by their gains for the week. The S&P gained only 1 point for the week, Nasdaq Composite 12 points and Dow 33 points. That is not the kind of market movement that inspires bullish confidence.

The economic reports on Friday should have been positive for the market. The bad news should have pushed the Fed even farther into 2017 for the next rate hike. The bad news started with the Producer Price Index for July.

The headline inflation at the producer level fell -0.4% compared to a rise of +0.5% in June and expectations for a rise of +0.1%. This was the first decline since March. Inflation in food prices fell -1.1% and energy prices fell -1.0%. The core rate excluding those items was flat at zero for the second month. If you do not eat or use energy, your inflation rate for July was zero. The rest of us saw a price cut.

Inflation for services fell -0.3% and the biggest drop since March. Inflation for personal consumption items fell -0.4%. Processed energy goods prices rose +0.8% even though energy prices were falling in July.

The drop in inflation at the producer level will be a concern for the Fed and will probably put the rate hike hawks back in their cages for the September meeting.

The Retail Sales report for July was also bad news. Headline sales growth was flat at zero compared to a +0.8% rise in June. Analysts were looking for a 0.4% rise. It should be noted that Amazon's Prime Day shopping spree was in July and even that did not lift overall sales for the month.

The nonstore sales category did rise +1.3% because of Prime Day but it could not offset declines elsewhere. Gasoline stations saw sales decline -2.7% due to falling gas prices. If you exclude this category, the overall core sales would have improved slightly to only -0.1% decline. Sales at sporting goods stores fell -2.2%, grocery stores -0.9%, general merchandise -0.1%, clothing -0.5%, food service/drinking -0.2%, electronics and appliances -0.1%, building materials -0.5% and food & beverages -0.6%. Autos and auto parts was the big gainer at +1.1% growth.

This is going to be a challenge for the Fed. I am sure in Yellen's Jackson Hole speech she will say these items are "transient" and will eventually show growth because consumer was the main driver in Q2-GDP. However, the retail sales reports we saw last week showed that every retailer saw revenue declines as consumers keep their money in their pocket.

The uncertainty of the election cycle is causing all kinds of ripples in the economy. Wendy's and Shake Shack both warned the election cycle was slowing sales of fast food.

Consumer sentiment for August rose only slightly from 90.0 to 90.4 compared to analyst estimates at 91.5. The current conditions component fell from 109.0 to 106.1 but the six-month expectations component rose from 77.8 to 80.3. Apparently, some people believe the political rhetoric about the good things they are going to do for jobs and the economy when they are elected. Those people need a course in government since promises rarely come true and if they do, it is normally years later.

The longer-term path on this chart is lower. Sentiment has been weakening for the last year since the high in January 2015 at 98.1. However, record low mortgage rates are providing support to sentiment or the chart would be a lot worse.

The economic calendar for next week has the FOMC minutes of the last meeting and the Philly Fed Manufacturing Survey. The minutes will be a critical inflection point for understanding Fed policy and how the weak economic data might impact their thinking for the September meeting.

The Philly Fed survey is seen as a proxy for the national ISM report due out in two weeks. If the Philly survey is weak then the ISM is expected to be weak. Analysts are expecting some improvement in the Philly survey from the -2.9 reading in July to a +1.5 for August. Given the recent economic reports, they may be setting their sights a little high for this one.

The Fed's Jackson Hole meeting the following week is always a weak point for the market. When you get that many Fed heads together in one place it is a target rich environment for reporters always looking for that next sound bite that could rock the market. Finding a Fed head accidentally afflicted with foot in mouth disease is always a plus.

It was a quiet day for earnings as the cycle comes to a close. JC Penny's (JCP) reported a loss of 5 cents compared to estimates for a loss of 15 cents. That was significantly better than the loss of 40 cents in the year ago quarter.

Revenue of $2.918 billion missed estimates for $2.933 billion but sales did increase 1.5% over the year ago quarter. Same store sales rose 2.2% after a -0.4% decline in Q1. They ended the quarter with $429 million in cash and $2.981 billion in inventory. The company guided to same store sale growth of 3-4% for the full year and for margins to rise 10-30 basis points. EBITDA is expected at about $1 billion. The company said they were seeing a sharp rise in business at malls where Sears and Macy's were closing stores.

Shares spiked on Thursday on some of the other retail earnings but rose another 6% on Friday on the better than expected report.

Ruby Tuesday (RT) reported earnings of 7 cents on revenue of $296.81 million. Same store sales fell -1.4%. The CEO said, "Our quarter was impacted by the softness in the casual dining industry and increased promotional activity by our peers. Given that we expect the macro environment to remain challenging for some time, we are taking the necessary steps to change the trajectory of our business." The company said it plans to close 95 underperforming restaurants by Sept 5th. Today they have 724 stores in operation. They guided to full year earnings of 5-9 cents and same store sales to be flat to up 2%. They may also close another 5-10 stores as leases expire.

Are we starting to see a pattern here? Nearly all of the restaurants reporting earnings are complaining about weak traffic and all have to resort to discounts and special promotions just to maintain prior sales levels. What does this say about the U.S. economy in general? If consumers cannot afford a hamburger, the economy is not headed in the right direction.

Applied Industrial (AIT) reported earnings of 66 cents that matched estimates. Revenue fell -6.4% to $634 million that missed estimates for $642 million. They guided for full year earnings of $2.40-$2.60 and analysts were expecting $2.66. Shares dropped -5% on the news.

Concordia International (CXRX) reported earnings of $1.38 compared to estimates for $1.42. Revenue was in line with estimates. However, they lowered full year guidance to $859-$888 million compared to estimates for $939 million. They guided for earnings of $510-$540 million and analysts were expecting $575 million. The company also suspended their 7.5-cent dividend in favor of using the money for "long-term value-creating initiatives or debt repayment." The stock crashed -38% on the news.

Acacia Communications (ACIA) reported earnings of 77 cents and revenue of $116 million. Analysts were expecting 30 cents and $85.8 million. Yes, that is not a misprint. They knocked the earnings ball out of the park. Even gross margin rose from 41.9% to 47% and well above the year ago level of 35%. They guided for the current quarter for revenue in the $120-$128 range and earnings of 64-76 cents. Analysts were expecting $92 million and 43 cents. Shares rallied 41% on the news. This company just came public at $30 three months ago and shares hit $98 on Friday.

With 91% of the S&P having reported earnings, the blended decline is now -3.5%. The blended revenue decline is now -0.2% and slightly better than the -0.8% forecast at the end of June. This is the first time the S&P has recorded five consecutive quarters of earnings declines since 2008-2009. This is the sixth consecutive quarter of revenue declines. Of those reporting 70% have beaten on earnings and 54% have beaten on revenue. On June 30th, the forecast was for a -5.5% decline according to FactSet. For Q3, 62 companies have issued negative guidance and 28 companies have issued positive guidance as of Friday.

The trailing 12-month PE is now 19.5 and the highest level since 2010. On December 31st, the trailing PE was 17.9. The forward PE is 17.1 based on the 12-month EPS estimate of $128.11.

Q3 earnings are currently expected to show a decline of -2.0% but Q4 is expected to show earnings growth of 5.5%. Revenue is expected to rise 2.2% in Q3 and 4.9% in Q4. The improvements in both metrics are due to easier comps from the same periods in 2015.

It would appear we have turned the corner in earnings. Typically, earnings come in better than the prediction as earnings surprises appear. That suggests the actual earnings decline in Q3 to be around 1% followed by close to 6% growth in Q4. If you were going to buy stocks, you would like to buy them as they rebound from an earnings recession. That means dips are likely to be bought over the next six weeks.

The earnings calendar for next week is retail oriented once again with DKS, URBN, AEO, HD, LOW, SPLS, TGT, GPD, ROST, SHLD, WMT, FL and HIBB. That is a heavy dose of retail earnings that could further build the case for consumer health or a continued decline.

The last three Dow components report. Those are HD, CSCO and WMT. They are not likely to move the Dow needle unless they post significantly stronger numbers than expected. Home Depot would be my pick for an upside move and CSCO/WMT a tossup for a downside move.

Hewlett Packard Enterprise (HPE) said it was buying Silicon Graphics (SGI) for $275 million or $7.75 per share. This is a great deal for HPE and a good deal for SGI as well. That was a 30% premium and they will do much better under the HPE umbrella. SGI makes high performance computers and the addition will complement HPE's big computer business.

Hain Celestial (HAIN) exploded higher on Friday on no news. Option volume is typically 1,300 contracts a day. By noon, they had traded over 13,000 and by the close, more than 55,000 call contracts traded. Average daily stock volume is 1.2 million shares and they traded 6.5 million on Friday. They report earnings next Thursday but the rumor was a possible acquisition to be announced next week.

Yahoo shares surged 4% to a 52-week high on Friday after blowout earnings by Alibaba caused a $13 surge in BABA shares over the last three days. Yahoo owns 15% of Alibaba, currently worth more than $36 billion. Yahoo's market cap at the close on Friday was $41 billion. Even after Verizon pays roughly $5 billion for the Yahoo core assets, there is still a lot of value left in the corporate shell. Yahoo still owns 35% of Yahoo Japan and that stake is valued at roughly $9 billion. Unlike Yahoo USA, Yahoo Japan has produced record revenue and profits for 18 consecutive years.

The Japanese portal produces more than 4,000 articles a day from its contributors and 300 media partners, has a multitude of online services including a credit-card business, a video on demand service and dozens of popular mobile apps. They generate 63 billion page views a month. They pay roughly $236 million a year to Yahoo USA for licensing and technology. If Marissa Mayer had just copied Yahoo Japan she would be flying high today instead of on her way out the door. Softbank owns 43% of Yahoo Japan.

In a SEC 13-F filing, David Tepper's Appaloosa hedge fund sold $500 million in SPY calls. They added $68 million in shares of WDC, $117 million of Atlantica (ABY) and sold all $418 million in Delta (DAL) and cut their Southwest (LUV) stake by 20%. The fund increased their stake in Allergan (AGN) from $75 million to $300 million. They sold all 1.6 million shares of Facebook (FB), 7.0 million shares of Bank of America (BAC), 2.5 million shares of Pfizer (PFE) and 1.3 million shares Cabot Oil & Gas (COG). Overall, he reduced his stock holdings by one-third to $3.80 billion, down from $5.66 billion in the prior quarter.

The key point in that paragraph for me is closing the SPY call position. He had more than $500 million in S&P calls and now has only $5 million. That suggests he was not confident the market was going to continue higher. Unfortunately, for him, this 13-F filing was for the end of June and the S&P hit its three-month low on June 27th with the SPY at $198. The ETF closed Friday at $218. Of course, the filing does not say when in Q2 he sold those calls or when he bought them. If he bought them in February he was still a big winner.

Maybe this time it is different. A constant stream of headlines from OPEC members suggest Saudi Arabia is ready to actually support a move to stabilize oil prices. Saudi needs crude back over $50. Their increasing debt levels and declining FX reserves have caused a shift in their thinking. OPEC production is at historically high levels with production of 33.11 mbpd in July. That is the highest level since 2008. It would not hurt anyone to actually freeze production and give the market time for demand growth to catch up to production. It would allow the OPEC countries some breathing room if they could get oil back over $50 and that would give them confidence to maintain a production freeze and try to push prices even higher.

Lastly, Saudi production hit a record 10.67 mbpd in July and analysts claim they are pretty close to being at their max production capability. That is another reason to support a freeze. If they cannot produce any more but Iran and Iraq can, then not having a freeze would let those countries continue to grow and win back market share. This time it is different for Saudi Arabia and once they say they will support a freeze, the prices will be over $50 very quickly. It is amazing how quickly the OPEC members turned around the expectations for further declines under $40 after Labor Day. Once the chatter began in earnest, the prices rebounded very quickly.

U.S. producers must believe in the chatter as well. The active rig count rose by 17 rigs last week and 15 of those were oil rigs. That pushes the total oil rigs reactivated to 66 over the last 7 weeks. Obviously, there is a long way to go to get back to prior levels but this is a fast start. U.S. production has declined -1.165 mbpd since early 2015. Current production is 8.45 mbpd and that has not gone down since the low of 8.428 mbpd for the week of July 1st. Production is not rebounding but has apparently found the bottom. Multiple U.S. producers guided for higher production in the second half of 2016 despite the low prices. If prices suddenly rocket past $50 on more OPEC chatter, we could see dozens of rigs reactivated each week.




The Nasdaq has posted gains for seven consecutive weeks and that has not happened since 2012. The Nasdaq can thank the biotech stocks and the semiconductor sector for those gains.

Despite that admirable winning streak, the index is still only 14 points over the prior historic high of 5,218 in July 2015. The big question today is whether the Nasdaq and the supporting cast can extend those gains after a 7-week sprint. There have been negative days in that streak but very few and very minor. Whenever we see a streak like that on any stock or index that matches a prior high, the bearish sentiment begins to flow out of the investing forest.

This is the equivalent of standing next to a roulette table and seeing red come up 7 spins in a row. The obvious expectation is that the next spin or at least over the next several spins a black number will appear. I have seen a lot of money won and lost betting those color streaks will come to an end.

I have done it a lot at the craps table. If somebody throws 5 or 6 sevens in a row, I am definitely throwing down black chips to bet against the shooter.

In casino table games, the law of averages always prevails. In the market, those laws do not apply regardless of how much we want to bet with/against them. The market can always continue a streak far longer than we can remain liquid betting against that streak.

For every 1,000 investors betting the Nasdaq cannot go higher, there is another 1,000 betting it will. What decides the outcome is the size of the bets on either side. If I am betting against a continued streak, I can easily become road kill. If David Tepper is betting against it with $500 million in SPY calls/puts, etc, then the market is likely to go in his favor because his volume far outweighs my volume and the other 999 investors on my side.

So here is the challenge. We are entering the six most volatile weeks of the year starting the week after August option expiration. Market lows in the second half of the year are typically set in that 6-week period. Are we going to have a lot of portfolio managers bet on that seasonal streak by either closing positions or actively shorting the market or will there be more managers chasing prices higher? Who has the biggest cash hoard and which way are they betting?

I would hesitate to bet against the seasonal weakness but the trend is our friend until it ends. As of Friday's close, the Nasdaq trend was still intact with a new record high. The Dow and S&P posted minor losses but they are still in the game.

I believe we should be observant and not overly long. I would rather keep some cash on hand in anticipation of a dip but keep some invested in case that dip does not come.

Another part of this scenario is that a lot of portfolio managers and individual investors were caught off guard by this rally. I am sure you have heard this was the "most hated rally ever" in the financial press. Bank of America continued a running scorecard of the 17 consecutive weeks of outflows from equities despite the gains in the indexes.

Now everyone who missed out on the rally will be looking for a dip to buy. While that may not happen in any volume before Labor Day, you can bet that any material dip after the holiday will be bought in volume. Portfolio managers will be back from summer vacation and they will have a limited time to post some gains and try to meet their benchmarks and beat their peers. They need to do this to keep their jobs and earn their bonuses. That means the race will be on once the starters gun sounds. We just do not know when that will be.

Remember, Q3 earnings are just expected to be mildly negative but Q4 earnings are expected to grow 5.5%. That means the earnings recession is nearly over and portfolio managers will be bulking up on equities to capitalize on that rebound.

The fly in our soup is the election. The uncertainty is so bad that fast food restaurants are warning of slowing sales in their earnings reports. With 85 or so days until the election, the mudslinging is going to reach a fever pitch. If the polls remain this far apart in the weeks that follow, the uncertainty may fade. When there is an apparent winner weeks ahead of the election the market tends to charge ahead as though the election was already over.

To summarize, the six most volatile weeks of the year begin after option expiration. There is a massive amount of cash on the sidelines and investor sentiment is still mostly neutral/negative. Fund managers are underperforming and they need to suit up with their shoulder pads and running shoes and get in the game after Labor Day. I am looking forward to September and the potential for a real breakout to new highs. (I am sure I am going to get a ton of emails on this outlook. I do welcome your thoughts by email. We have some smart readers and I learn something every week from our subscribers.)

The Nasdaq closed at 5,232 with a 4 point gain and only 14 points over the prior historic high. That is still not a breakout in my book. It is more of a slow motion resistance test. Initial support remains 5,200 and a critical level to watch. Initial resistance is the intraday highs for the last week around 5,235.

The last three Dow components report earnings next week on three different days. The potential for a market-moving event is slim but always possible. The Dow benefitted from the spike in oil prices on Friday with Chevron and Exxon the biggest gainers on the index. The Dow was flirting with the lows at 18,540 when oil started to spike and the short covering in those two names lifted the Dow back to 18,574 at the close.

The index has developed an interesting chart pattern with multiple lines of resistance all converging right at the 18,600 level. The Dow punched through multiple levels of resistance to get to where it is today and a breakout here would set it free. Support is 18,500 and 18,250.

The S&P refuses to decline more than a couple points at a time and then we get one good day that recovers those losses. The long-term resistance that corresponds to the red line on the Dow is roughly 2225-2230 on the S&P. Initial resistance from the last four days of intraday highs is roughly 2,187 with support at 2,150. I do not really see that support breaking without a major change in market sentiment. Anything is always possible but the dip buyers are alive and well.

The Russell 2000 has not made a new high. The current 52-week high is 1,231.75 with the historic high at 1,295. The Russell has not been moving up as strongly over the last four weeks as it did in the first three weeks of the rebound from 1,095. What we have is a scenario where a few big caps are leading the charge and the troops are lagging behind. This needs to change after Labor Day if the market is really going to move significantly higher.

I think I was clear in my commentary. The market has been successful in bucking the normal seasonal weakness but the momentum has slowed significantly. I do expect some volatility to appear but be tempered by some aggressive dip buying the closer we get to Labor Day. Volume should continue to be very anemic and that favors the bulls in this case, which is unusual.

I prefer to refrain from being overly long and I recommend we keep some cash on hand to buy any material dip over the next several weeks.

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Random Thoughts

Sentiment levels were mostly unchanged last week, which is just one more indication investors are not paying attention to the market. Volume remains very anemic and should decline even more over the next two weeks with the exception being option expiration.

Bullish sentiment rose slightly by +1.5% and it came from neutral investors moving off the fence. Bearish sentiment was unchanged. Sentiment will likely remain unchanged until after Labor Day.

The conventional wisdom is that the markets do poorly in late summer in election years. However, there was an article on Friday that pointed out since 1952 the last 7 months of the election cycle was strong in all but two years. In the 16 presidential election years since 1952, the market only declined twice. August was actually a strong month in election years according to this research. I have not seen the actual data behind the article but I have to admit I was surprised at the headlines.

Another study by Kensho found that the Russell 2000, Nasdaq and Dow posted an average gain of only 0.5% in the month after a triple index high like we saw the prior Friday. The S&P averaged a decline of -0.5%. There were 132 triple index highs since 1986.

That study is not encouraging because it suggests stocks tend to flatten out after a triple index high. On the positive side, the energy sector is up an average of 3.17% and was the leading sector. Apparently, the euphoria over new highs suggested oil demand would rise and push prices higher.

The worst sectors were the consumer discretionary (XLY) at -6.48% and the financials (XLF) at -5.78%. The technology sector (XLK) lost -3.66% and the consumer staples (XLP) fell -3.45%.

The flight to safety trades did poorly as you would expect with stocks making new highs. The dollar and ten-year treasury declined about 0.4% but gold averaged a 0.5% gain.

Mark Twain once wrote, "There are three kinds of lies. There are lies, damned lies and statistics." Another person once said "Statistics can be forced to say anything if you beat then long enough." The point here is that averaging the market performance over the last 132 times there was a triple index high is an exercise in futility because our future on this 133rd high has no relation to the past. There are so many factors that go into market highs that it would be impossible to find an exact match in the past to what we are seeing today. Nowhere in the past was there $13 trillion in government bonds yielding a negative interest rate. Never before was the Japanese government buying $1 trillion in stock ETFs. Never before have we had two presidential candidates as equally disliked, each with 61% disapproval ratings.

A Billionaire Census by Wealth-X found that the world's 2,473 billionaires are sitting on $1.7 trillion in cash of about 22.2% of their wealth. The study found that uncertainties in the economy were weighing on billionaire sentiment.

While that may sound like a lot of cash to hoard on a percentage basis a different study by UBS in July found that "wealthy" Americans were keeping around 20% of their wealth in cash. That was equal to the post 2008 average. UBS said many are considering reducing their exposure to the markets because of uncertainty over the presidential elections.

The Wealth-X report said billionaires were waiting for the equity markets to return to more attractive levels before putting the money back to work.

For you Star Wars fans the new trailer for the next installment in the Star Wars series broke this weekend. The "Rogue One" movie will be released by Disney in December. Darth Vader will return in this episode. You can watch it here.


Enter passively and exit aggressively!

Jim Brown

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"The future depends on what we do in the present, because Tomorrow is often the busiest day of the week."

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