Janet Yellen and Stanley Fischer played good cop, bad cop on Friday but it translated into good dove and bad hawk.

Weekly Statistics

Friday Statistics

Janet Yellen caved in to the pressure and spoke about the chance for a rate hike in 2016 but there were so many qualifiers that nobody believed her. The market rallied on the seemingly dovish comments. The most hawkish comment Yellen made was "In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months." That is hardly a warning to prepare for a September to remember. Stocks rallied after she qualified that with several more sentences about data dependent conditions would have to be met. The lack of specificity on a timetable suggested a hike would happen later rather than sooner.

Two hours later Vice Chairman Stanley Fischer warned that September was not only a live meeting but potentially the first of two hikes over the next four months. When Fischer was asked in a live interview if the market should prepare for a rate hike in September and maybe again in December, he replied "Yes, if the data cooperates." He warned that the country was at full employment and a strong jobs report next Friday would have to be taken into account at the September meeting. He also tried to correct the lack of focus in Yellen's comments saying, "Her comments were consistent with a September hike and possibly two hikes this year, but the Fed will not know the course of policy until it sees the data." He warned that inflation was nearing the Fed's 2% target and the Fed should be preemptive rather than reactive meaning it should hike in advance rather than waiting for all conditions to be fulfilled before acting.

Fischer's demeanor was compared to somebody that wanted to make sure there was at least one hike in 2016 so he was trying to ratchet up expectations for two just to guarantee at least one hike. If you constantly prepare everyone for two hikes then only one hike becomes the middle ground where everyone can agree.

The Dow spiked +122 points to 18,572 on Yellen's comments, fell -237 to 18,335 on Fischer's comments and then rebounded +63 points into the close. Volatility returned for several hours on Friday.

St Louis Fed President James Bullard said Friday he favors raising rates in September and then doing nothing for the next two years. Bullard recently converted to a dovish stance and is now the most dovish of all the voting members. He believes the economy is strong enough to move rates away from nearly zero but is not expected to be strong enough for further hikes for a long time. He pointed to the anemic GDP growth projected to be only 2% through 2018 as a reason the Fed should not move aggressively. He believes bad rate guidance has hurt the Fed's credibility.

Atlanta Fed President Dennis Lockhart said "I can see two rate hikes as possible with three more Fed meetings in 2016."

The chance of a September rate hike rose to 36% from the 18% chance I posted last weekend. The odds of a December hike jumped from 53% to 64% over the last week. Rate hikes are coming and the market is now pricing in at least one before the end of 2016.

The first revision of the Q2 GDP edged down slightly from 1.2% to 1.1% growth. That compares to 0.83% in Q1 and 0.87% in Q4. Needless to say the growth is very anemic and Yellen could easily wait until 2017 to hike rates because of the slow growth economy.

Consumption added 2.94% to the GDP while fixed investments removed -0.42%, inventories -1.26% and government -0.27%. Exports were the only other positive component with a 0.10% gain. Corporate profits declined -1.19%.

There are worries the current economic cycle is coming to an end. The current economic expansion has lasted 7 years and is the third longest ever. However, the Q3 outlook is still positive at 3.4% according to the latest Atlanta Fed real time GDPNow forecast. Using Stanley Fischer's preemptive model, September would be the right month to hike but what if the forecast was wrong? That is why Yellen's "wait for the data" stance is probably the one that will win.

The final revision in Consumer Sentiment for August declined minutely from 90.4 to 89.8. That is the lowest level since the 89.0 in April and the second lowest since the 87.2 last September. Sentiment is still fading from the 11-year high in January 2015 at 98.1 and the outlook is bearish. The present conditions component fell from 109 to 107 and the expectations component rose slightly from 77.8 to 78.7.

The next several months in an election year typically see a decline in consumer sentiment. In the period from July-Jan in 2012, the average was 75.3 with a low of 72.3 suggesting we have farther to fall. Politicians are telling consumers how bad things are and how they are going to fix it. Unfortunately, the promises never come true and consumers are left with the low outlook until the next spring.

On the positive side, the low mortgage rates and falling gasoline prices are helping to support sentiment.

We have a full calendar next week with the employment reports and the national ISM Manufacturing Index. Any of those events can move the market but the big one to watch is the Nonfarm Payrolls on Friday. The expectations are for a reading of 160,000 but there are whisper numbers at 180,000. Any number over 200,000 is almost a guarantee of a rate hike at the meeting on September 20th. That means the market will be very cautious on the lead up to Friday if the ADP report on Wednesday is strong. Currently the forecast is for a gain of +165,000 jobs.

The ISM Manufacturing Index is struggling to hold over 50 after a reading of 52.6 for July. The manufacturing sector has shown spotty results in the various regional reports with the Philly Fed Manufacturing survey barely posting a gain with +2.0 last week. The Richmond Fed Manufacturing Survey fell from +10 to -11 last Tuesday. Factory orders have been in negative territory for several months. This makes the ISM important for the Fed's rate hike outlook.

The Herbalife (HLF) war heated up again on Friday. Bill Ackman, who has a $1 billion short on HLF in his Pershing Square hedge fund, said he was contacted by Jefferies to see if he was interested in buying Carl Icahn's 17 million share stake. They contacted him in case he was interested in buying some shares to cover his existing short. The story made headlines all day with Ackman hyping the sale attempt saying Icahn was selling the shares because "Herbalife is toast" under the new marketing plan demanded by the government. Icahn was contacted during the day but had no comment. The story started with an article in the Wall Street Journal.

After the bell, Icahn announced he bought another 2.3 million shares. After being down as much as $4 intraday to $57, the stock rallied to trade over $64 in after hours. Icahn has permission from Herbalife to acquire up to 35% of the company. After Friday's acquisition, his stake has risen to 20.8%.

As the smoke cleared late in the day, Icahn said he never gave Jefferies permission to shop his position, worth more than $1 billion. Jefferies then said it never received a sell order from Icahn or anyone at his firm. Both of those claims could be "technically" correct but factually untrue. Icahn and Jefferies could have been testing the water after shares have declined for three weeks. If a willing buyer was found, Jefferies could have communicated the price back to Icahn and then a decision could have been made. Unloading $1 billion in stock in a questionable company would be a challenge. Icahn could not wake up one morning and just put in a sell order and have it executed. There are 93 million shares outstanding and Icahn now owns roughly 20 million. Average daily volume is 1.9 million. It would decimate the price to have 20% of the stock suddenly available for sale. Until Friday's purchase, Icahn's average price was in the $32 range. He may have a huge paper profit but until those shares are sold, there is no actual profit.

Several times over the last three weeks I tried to come up with a long-term put option trade that would work but the premiums were sky high and the bid/ask spreads too wide. Nearly everyone believes the long-term outlook under the new government mandated marketing plan, is going to mean a lot smaller profit and a very small sales force. The new plan says the majority of commissions must come from selling the product to retail customers rather than signing up new distributors. That is going to dramatically slow sales because the distributor workforce is going to evaporate.

Tesla (TSLA) won antitrust approval from the FTC to acquire SolarCity (SCTY). While nobody expected any objection, the early approval from the FTC means the waiting period has expired. Elon Musk will still have to receive approval from SolarCity shareholders. Those investors holding SCTY shares would receive 0.11 shares of Tesla per share of SCTY. Today that is worth $24.20 and Musk initially offered $26.50-$28.50 per share. Shares were trading over $27 when the final agreement was announced. Since Musk and his cousins are majority shareholders in SCTY and they have agreed not to vote their shares it will be interesting to see of the remaining shareholders actually vote for the take-under.

Shares of Pure Storage (PSTG) erased a 13% gain to close negative after reporting earnings. The company had a Q2 loss of 16 cents that was better than the 23-cent loss analysts expected. Revenue surged 93% to $163.2 million and beat estimates for $155.2 million. They guided for Q3 revenue in the range of $187-$195 million and analysts were expecting $191 million. Volume was 8 times normal and shares spiked to $13.50 at the open after a prior close at $11.82. Almost immediately, sellers appeared and shares fell back to $11 intraday and closed at $11.38. JMP Securities blamed it on the weakness in the storage sector. Nimble (NMBL) Storage did the same thing early in the week. This is related to the warnings from Seagate that demand from cloud companies is slowing.

I think the key here is the rapidly growing size of disk capacity. With 8 terabyte drives now common and 10 terabyte drives coming, it takes a lot fewer drives to hold the rapidly growing cloud data. Three years ago, a 2 terabyte drive was the new hot commodity.

Three years ago, a "high capacity" server had the capacity to hold 16 drives. SuperMicro (SMCI) recently announced a 90-drive server. The amount of data that one server can now hold is off the scale of human comprehension, at least for this human. A terabyte is 1,000 gigabytes or in round numbers 1 trillion bytes. Using the new 10 terabyte drives and the 90-drive server there would be more than 900 terabytes of data on one server. You lose some in the formatting process and some in your RAID configuration, but that is still a lot of data.

To put it into perspective, the Library of Congress claims to have about 600 terabytes of data in its files. Ancestry.com has 600 terabytes of data that contain all the census data on every individual from 1790 to 1930. Yahoo has about 100 terabytes in its historical website files since inception. Pictures are big but the Hubble Telescope has only collected 45 terabytes of pictures in its 20-year history. To backup one terabyte of data requires more than 220 DVDs.

The bottom line is that it takes far fewer drives today to hold much more data and storage companies have discovered the law of diminishing returns.

SuperMicro Servers

Ulta Salon (ULTA) finally stumbled. The company reported earnings of $1.43 compared to estimates for $1.39. Revenue was $1.07 billion compared to estimates for $1.06 billion. Same store sales rose 14.4% compared to 12.9% analysts expected. However, the retailer said it expected earnings of $1.25-$1.30 for Q3 and analysts were expecting $1.30. That one sentence caused the spectacular gains for the last six months to come to an end. This is definitely a buy the dip stock but wait until a rebound begins.

Autodesk (ADSK) reported a loss of 5 cents compared to estimates for 13 cents. Revenue of $550.7 million declined -10% but still beat estimates for $512 million. Autodesk is moving from a purchase model to a cloud subscription model and that always decreases revenue in the short term but increases it in the long term. Total subscriptions rose by 109,000 to 2.82 million.

This is the final week for stragglers reporting Q2 earnings. Palo Alto networks, Salesforce.com, Broadcom, Ciena, and Ambarella are the highlights for the week. There are still some retailers reporting with HAIN, ANF, DSW, FRED, GIII, ISLE, NCTY, CHS, FIVE, SCVL, BEBE, LE and LULU closing out the sector earnings.

More than 98% of the companies in the S&P already reported earnings for Q2 and the final results are available. Some 71% have beaten on earnings and 53% beat on revenue. Earnings declined -3.2% for the quarter making it the fifth consecutive quarterly decline. Revenue declined -0.2% and the sixth consecutive quarterly decline. For Q3, 77 companies have issued negative guidance and 33 have issued positive guidance.

Q3 earnings are expected to decline -2.2% and Q4 should see a +5.5% rebound in earnings growth. Revenue is expected to rise 2.2% in Q3 and 4.9% in Q4.

Apple CEO Tim Cook vested in his five-year anniversary bonus and it was a whopper. On Friday, Cook converted 1.26 million restricted stock units to common shares worth $135 million. He sold 990,117 shares to net $35.8 million after taxes. Cook now owns 1.3 million Apple shares and 3.5 million unvested stock units. Shares declined slightly on Friday but it was likely market related rather than Cook's share sale.

Amazon (AMZN) said it was going to build three new brick and mortar book stores in Chicago, San Diego and Portland. The company already has a large store in Seattle that it used to prove the concept. Amazon has many square miles of merchandise in inventory and they view these stores as a showroom for their hot items we well as books. Devices including the Kindles, Fire TV and Echo sell well when people can touch them and learn about their features. Amazon can also use the stores as test centers to see how customers react to new devices or new features.

Amazon's electronic devices are the top sellers on their website but they are just scratching the surface in the consumer market. Multiple analysts were saying Amazon should have bought Best Buy a couple years ago to get a jump start on showrooming their own products nationwide.

Amazon also announced Amazon Vehicles, an online platform for users to research cars, auto parts and accessories. The platform will include specifications, images and reviews for a large number of car models. Users will be able to compare prices and features. Analysts believe this is a prelude to selling cars on Amazon at some point in the future.

Amazon claimed another victim on Friday. Rackspace (RAX) said it was going to be acquired by Apollo Global for $32 a share or $4.3 billion. Amazon and Rackspace were fierce competitors in the cloud space but in the end, you cannot compete and win against Amazon. Rackspace pioneered a cloud operating system called OpenStack. A company could install its own datacenter and then choose OpenStack cloud services to move files, apps and services around to multiple cloud locations. That means the company would never be locked into one location and maintained complete flexibility. The product was very successful but Amazon Web Services (AWS) continued to take customers away from Rackspace. Eventually Rackspace partnered with Microsoft to sell and support the Azure cloud. RAX even tried to partner with AWS and sell a higher priced version of AWS that included a strong customer service component. Amazon has a bad reputation for customer service for AWS. You are pretty much on your own once you contract for cloud space.

Rackspace finally raised the white flag and gave up competing with the 800-lb gorilla. It will be interesting to see what Apollo will do with the company since RAX has tried multiple product offerings and been crowded out by Amazon at every turn. Analysts believe Amazon will eventually push even Google to the sidelines. AWS has already won the market share war and now they are just picking up the stragglers as they increase that share.

Oil prices faded late in the week after the Saudi oil minister Al-Falih said an oil output freeze would be "positive" if it happened but ruled out a production cut. "We will be willing to listen to our colleagues, what they have to offer in that area. I do not believe an intervention of significance is required." These comments were seen as evidence Saudi Arabia may not be totally on board with the concept.

"There is the freeze that is official, and there is the freeze that is practical," Al-Falih said. "Today, when you think about it practically, many countries today are at their capacity. Their room for an increase are limited, certainly for the short or medium term."

I wrote about this last week. With most OPEC countries already at maximum production, announcing a freeze would just be putting a new name on maximum production. However, Libya is slowly coming back online as well as Nigeria and neither of those countries are going to agree to a production freeze at their current output levels. Iran and Iraq are also increasing production so their participation is questionable.

The rebound in prices stalled at $48.50 and once past Labor Day we should see inventories build faster and prices decline.

Active onshore rigs declined -2 to 489 but oil rigs were flat at 406. Gas rigs fell -2 and offshore rigs declined -1. It will be interesting to see if that 8 week rebound in rigs can be sustained, decline or increase further. I suspect it would take $50 oil or higher to really get a lot of rigs off the sidelines.




The markets continue to tease investors with the potential for a move in either direction. Bulls see the repeated tests of the recent highs as evidence the market wants to go higher. Bears see the repeated failure at those highs as evidence the market wants to go lower. In this market, there is something for everyone but neither side is having any luck finding winning trades.

The S&P has moved sideways in a 40-point range since July 14th. That is the longest stretch of low volatility since before the financial crisis. Eventually this compressed market will break out of the consolidation trend and it could be explosive and it could move in either direction. The S&P has not made a 1% move in 35 sessions.

What happens over the next five weeks will likely set the stage for a longer-term move. With earnings expected to rise 5.5% in Q4 the most likely direction is higher once the volatility have passed. We are now one week into the six weeks of the year with the highest volatility with five to go. I seriously doubt we will continue sideways for five more weeks.

The S&P traded in a 27-point range on Friday and the widest range since this new high consolidation began in mid July. Despite the 27-point range, the index only lost -3 points to close at 2,169. The intraday low at 2,160 was a three week low. This could be the start of the volatility but it was also due to the conflicting comments from the Fed heads. There is still five days before the holiday weekend and volume should continue to be very low. After Labor Day is when the market should go directional. However, given the increased outlook for a September rate hike there could be a cloud over the market next week as well.

Support at 2150-2160 is the critical level to watch as well as the 2,193 double top intraday highs from the last two weeks. A break below 2,150 should retest 2,100.

The converging resistance on the Dow at 18,625 is still intact and the index lost -157 points for the week to test initial support at 18,350. The next test could be 18,250 and then 18,000. The Dow stocks are all in the post earnings depression phase and there are no catalysts to push the Dow higher.

The banks spiked slightly higher on Friday then faded into the close. The energy stocks are fading along with the price of oil. The drug stocks were weak on the drug pricing scandal surrounding Mylan. Retailers were slipping on poor sector performance and outlook. Every sector seemed to have some new headline that was weighing on prices.

On the positive side, there were no big losers. There were plenty of chances for Dow stocks to crater but the declines were only minimal. This suggests there are still plenty of dip buyers for the big caps.

If the 18,250 level breaks we could be in for a larger than normal decline ahead of the equity fund portfolio restructuring in September. Conversely, if a rally suddenly breaks out from here that takes the index well over 18,625 it could trigger significant short covering and price chasing by funds afraid the market is running away from them.

The Nasdaq managed to buck the trend on Friday thanks to a 1% gain in the biotech sector. The 62-point trading range ended with only a 6-point gain, but still a gain to lift the index a little farther above that critical support.

The biotechs have been the curse of the Nasdaq over the last several weeks. The biotech sector has seen big gains and losses and they are dragging the Nasdaq higher and lower depending on the day. The BTK closed at a five week low and slightly below support at 3,300. The sector could go either way next week but the Mylan price hikes are now old news. If I had to bet on a direction, it would be higher. That would benefit the Nasdaq and help prevent a meltdown under 5,200.

The Russell 2000 small caps are still in a positive trend. This is the most bullish index but it does have risk to the bottom of the channel at 1,225. As long as fund managers are nibbling at the small caps, the market is not in danger. When that changes, it could spell a change in direction for the big cap indexes first.

I am neutral on direction for next week. The Russell 2000 seems to be saying we will go higher but the Dow and S&P are at three-week lows. The big caps led us to new highs but have lost traction. The small caps were laggards on the early rally but are now the strongest section of the market.

This will be week two of the six most volatile weeks of the year and volume will be extremely light. That may be the saving grace because most institutional traders will be out of the office. It is the week after Labor Day that could set the tone for September.

I would continue to caution not to be overly long this week. Keep some cash available and a shopping list of stocks you would like to buy on a dip. We are long overdue for at least a minor bout of profit taking and it could appear at any time.

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Random Thoughts

Bullish sentiment reversed sharply with a -6.1% drop to 29.4%. Considering this survey ends on Wednesday that was before the anguish over the Yellen speech. Neutral sentiment rose +2.9% and bearish sentiment +3.3%. Bullish sentiment is about 10% under the normal average and neutral sentiment is 10% above average. Bearish sentiment is almost exactly at the 30.5% long-term average. Something scared the bulls early last week and that could carry over into next week.

Yellen warned because average job gains of 190,000 over the last three months and expectations for inflation to rise to 2% over the next "several" years and expected growth in the GDP, we should expect the Fed to raise interest rates gradually over time. That was about as neutral as you can get. Yes, we are going to raise rates but it will be data dependent and could take years to return to normal. It was hardly a hawkish speech but Fischer handled the bad news for her.

In Yellen's speech, she laid out several scenarios for dealing with the next recession. After seven years of expansion, the next recession cannot be that far away but that distance is measured in years not weeks. The most common forecast is for a recession to appear around 12-18 months from now.

The common question for the Fed is what to do when a new recession appears if interest rates are too low for the Fed to react with rate cuts. She theorized that rates in the 3% range would be sufficient for a future rate cut cycle along with $2 trillion of QE in order to stabilize the economy, unless the recession was unusually long or severe. If a dramatic recession were to appear, she suggested the Fed might delve into other asset classes for QE to be effective. Those would be stocks, ETFs and corporate bonds. Japan is already in this mode and now that the door has been cracked open, the Fed would like to have that ability as well.

She kept referring to "future policy makers" suggesting she does not plan on being around a long time. Given that the Fed has never unwound a stimulus program without causing a market crash and recession and the current stimulus program is the largest on record, she may be planning an exit before that unwinding occurs so she does not have to face the political heat.

Full Yellen Speech

The University of Chicago broke with a current trend when it sent a letter to new students telling them what to expect when they begin their intellectual journey.

Once here you will discover that one of the University of Chicago's defining characteristics is our commitment to freedom of inquiry and expression. Members of our community are encouraged to speak, write, listen, challenge, and learn, without fear of censorship.

Civility and mutual respect are vital to all of us, and freedom of expression does not mean the freedom to harass or threaten others. You will find that we expect members of our community to be engaged in rigorous debate, discussion, and even disagreement. At times this may challenge you and even cause discomfort.

Our commitment to academic freedom means that we do not support so-called "trigger warnings," we do not cancel invited speakers because their topics might prove controversial, and we do not condone the creation of intellectual "safe spaces" where individuals can retreat from ideas and perspectives at odds with their own.

Fostering the free exchange of ideas reinforces a related University priority - building a campus that welcomes people of all backgrounds. Diversity of opinion and background is a fundamental strength of our community. The members of our community must have the freedom to espouse and explore a wide range of ideas.

While I applaud their stance, many others did not. There was an immediate Twitter war between those that want to coddle students and treat them like grade schoolers and those who were cheering the university's stance. Some donors polled their pledges saying they were not going to support the uncaring stance, saying individual feelings should be protected rather than be exposed to harsh opinions of others.

I believe the university made the right choice. They are the first college to challenge "safe spaces" in an acceptance letter. There are no safe spaces and trigger warnings in life. The sooner these pampered children understand that the better off they will be in the world. Just my two cents.

Burning Man celebrates its 30th anniversary this year. The event starts on Sunday and runs through September 5th. If you do not already have tickets, it is too late to consider going. The general admission tickets at $340 plus an $80 parking ticket, sold out long ago and the ticket resale sites have been getting 2-3 times the face value but those have now evaporated. The event has changed from a bonfire on the beach outside San Francisco to a weeklong event with 70,000 attendees participating in sex, drugs and rock and roll. It is called a combination of Woodstock, Circus du Soleil and Alice in Wonderland all taking place on the planet Tatooine. The event is capped by the ritual burning of the wooden man, which is more than 100 feet tall.

Everything is free with nothing for sale except coffee and ice. Costumes are worn all the time along with those wearing nothing at all. The event attracts all kinds of celebrities including Katy Perry, Jim Belushi, John Stamos, Susan Sarandon, Will Smith and dozens of other actors just blending into the crowd. Mark Zuckerberg helicoptered in last year and handed out hundreds of grilled cheese sandwiches before getting lost in the crowd. Celebrities assume new names for the week so they can fit in with the regular crowd. Elon Musk and his cousin Lyndon Rive came up with the idea of starting SolarCity while they were camped out at the event. Put it on your bucket list if you are a free spirit under 40. Burning Man


Enter passively and exit aggressively!

Jim Brown

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"If you don't read the newspaper you are uninformed. If you do read the newspaper you are misinformed."

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