The last straw is the event that finally breaks the markets back. Eric Rosengren was the last straw.
The markets have ignored data point after data point for the last couple months with economic news weakening at every turn. The market has also ignored multiple Fed speakers offering multiple points of view that keep the Fed Funds Futures highly volatile. The market ignored the fifth consecutive quarter of negative earnings and a Q2 GDP revision at only 1% growth. After all, the Fed keeps telling us they are "data dependent" and when rate hikes eventually arrive, they will be gradual. The market ignored the hawkish comments from Mario Draghi when he failed to announce an extension to QE last week. The market ignored the BoJ Governor, Haruhiko Kuroda, when he appeared to have run out of options to save his sagging economy.
On Thursday the Fed funds futures were only showing a 15% chance of a rate hike in September. On Friday, Eric Rosengren was the last straw when he spoke about the need to hike rates sooner rather than later and implied the Fed would move in September. The Fed futures spiked to a 24% chance of a rate hike and the equity markets declined the steepest since the Brexit vote on June 27th.
There were complications. With a quadruple option expiration next Friday, portfolio managers and traders normally clean up their option positions on the Friday before that quadruple witching. That helped to increase the volatility. Also, over the prior two days I have seen sharp unexplained declines on no news on multiple stocks. They were mostly prior winners and I wrote in the Thursday newsletter it appeared fund managers were locking in profits and raising cash ahead of the Fed meeting on the 20th. There was likely some caution as well about the 15th anniversary of 9/11 on Sunday. Al Qaeda is fond of anniversaries and there is always the potential for a new attack in the USA.
When the combination of Draghi, Kuroda and the Fed all appearing to be near the end of their stimulus cycles, the next move would be rate hikes. Draghi's comments and lack of action were thought to have been the result of a call from the Fed suggesting a rate hike at the next meeting. In order to prevent further damage to the Euro, he elected to pass on further stimulus. When Rosengren, a former dove, came out strong on the need to hike rates, it was the last straw for the market. The weight of all those prior straws suddenly caused a high volume crash and the two-month consolidation pattern was broken.
Adding to the confusion was a sudden announcement that the Fed's most dovish governor, Lael Brainard, would speak on Monday at 1:PM on the last day before the quiet period begins ahead of the Fed meeting. If she has a hawkish tone, it will be a sure sign the Fed is planning on hiking in September.
I wrote last week after the several negative economic reports, if the FOMC was planning on hiking rates in September they would have to produce multiple speakers before the meeting to warn the market a hike was coming. Since the Fed claims it is "data dependent" the data was suggesting no hike. Since I wrote that, there has been a steady stream of hawkish comments and squeezing in Brainard at the last minute could be the final warning. However, if she maintains her dovish tone maybe she was recruited at the last minute to throw cold water on the hawkish comments from others. Hers will be the last speech before the Fed meeting.
I have written many times warning that when the 4th tightest range since 1928 finally broke it was going to do it explosively. Friday was explosive. Volume was 8.44 billion and 7.69 billion was down volume. Decliners were 10:1 over advancers. New highs fell from 736 on Wednesday to 94 on Friday.
In theory, 10:1 down volume is considered a capitulation day. That means everyone rushed to the exits at once and the weak holders were eliminated. While I would like to think that was the case, I seriously doubt it. Too many support levels were broken in one day and the market closed on the lows. I would expect Monday to be down as well as traders race to cover their margin calls.
Now that the range has broken, it is entirely conceivable that we could decline another 1-2% to prior support in the 2,100 range for the S&P and 17,925 on the Dow. Any declines below those levels would face the potential for a real washout to 17,000 and 2,050.
For the last two months we have seen dip buyers appear on every dip. They never appeared in volume but it was enough to keep the indexes in the consolidation pattern. Those dip buyers were obliterated on Friday.
The only economic report on Friday was the Wholesale Trade for July. Wholesale inventories remained flat after posting solid gains in the prior four months. Durable goods inventories rose +0.3% and nondurables declined -0.3%. Sales fell -0.4% with nondurable goods sales falling -1.0%.
The economic calendar for next week is heavily loaded for Thursday. The Philly Fed Manufacturing Survey is the most important but retail sales will be a close second. There is a strong possibility sales will be negative even though the consensus estimate is for a minor +0.1% gain.
This is a quadruple option expiration week and volatility could remain elevated. However, it would take a continued crash to push it higher than Friday's +39.9% spike to 17.50 on the VIX.
The Fedspeak on Friday caused treasury yields to spike to a two-month high with the ten-year yield rising to 1.672% compared to 1.52% on Wednesday after Tuesday's weak ISM and the lackluster Beige Book. Anyone who bought treasuries over the last two months has already lost in principal more than they will earn in interest over the term of the investment. If the Fed is truly about to embark on a rate hike cycle it is going to be very painful for holders of treasuries.
With $13 trillion in global bonds now offering a negative yield, there could be a race to the exits if it appears rates are going to rise. Switzerland and Germany are selling new 10-50 year debt with negative yields. That means the buyers will get back less money than they paid. This suggests those investors expect economic growth to remain stagnant for years.
Apple (AAPL) shares have collapses since their iPhone 7 announcement. Apple shares closed at $107.70 on Tuesday. I wrote in the Tuesday commentary, "Typically, Apple shares decline on the announcement. Active traders may want to pick up some puts on Wednesday morning. The September $107 puts with 10 days until expiration were $1.19 at the close. Apple shares could easily drop to $105 or so without any unexpectedly good news in the announcement." After Apple said it would no longer report initial sales numbers the stock fell harder than normal to close at $103 on Friday and was a major drag on the Dow and Nasdaq. That $107 put was worth $4.05 at the close on Friday.
Apple did not make any friends with the announcement and the realization the missing headphone jack rumors were true. In order to blunt criticism, Apple is including this cheesy dongle that will allow you to use your existing headphones on a new model 7 phone. However, Apple fans were quick to point out that it would be impossible to charge your phone and listen to music at the same time. Since battery life issues are a common complaint with Apple phones, it means you cannot listen to music when your phone needs to be recharged.
On the positive side, dropping the headphone jack allowed for 14% larger battery and upping the size to 1955mAh. Apple claims that will add 2 hours of battery life to a normal phone.
Apple fans were also excited about the new glossy "piano black" or glossy black color option. The phone looks really nice BUT Apple put a warning on their website that says the phones are prone to "micro abrasions" or scratching. Apparently, even with as little as one day of use, even when being especially careful, the scratches become easily visible and several weeks of use can trash the glossy aesthetics of the phone. Buyer beware, the new phone may look old relatively quickly.
Apple also said it was refocusing its efforts on self-driving cars. Apple closed several parts of the self-driving car project and laid off dozens of employees. The project code named "Titan" has struggled to make any progress. Sources said Apple was going to move away from actually building cars and concentrate on building self-driving technology that could be licensed to auto manufacturers.
Credit Suisse added Apple to their "Focus List" with a price target of $150. That analyst must have been smoking something funny when he issued that note.
Chipotle Mexican Grill (CMG) settled cases with more than 100 customers that became ill after eating at Chipotle stores. Terms of the settlement were confidential. Shares declined $10 with the market but they are still up $25 since Monday when Bill Ackman announced a 9.9% stake in the company.
Deutsche Bank (DB) is close to a settlement with U.S. regulators over past problems with subprime loans. The bank is expected to agree to a fine of $2.4 billion. Some analysts had expected a fine of up to $3.4 billion. The bank is also under fire for manipulation of foreign exchange rates, gold and silver pricing, and rigging of the borrowing benchmarks of Libor and Euribor. DB agreed to pay another $1.9 billion in 2013 on $14.2 billion in subprime loans where the loans were misrepresented.
Deutsche Bank also announced on Friday it was redeeming eight bond futures ETNs. The prospectus allows the bank to redeem them at any time at its sole discretion. The ETNs they are redeeming are LBND, SBND, BUNT, BUNL, JGBT, JGBL, JGBD and JGBS. Five of those are 3x leveraged ETNs. All of the ETNS had very low volume with some less than 1,000 shares a day.
JP Morgan (JPM) is no longer getting the respect it did in prior years. On Friday Macquarie cut its rating from outperform to neutral on valuation. The analyst price target is $70 with JPM at $67. That broker is not the only one turning negative on JPM. The last six ratings changes have been negative.
Macquarie - Outperform to Neutral
Bernstein - Outperform to Market Perform (Neutral)
Citigroup - Buy to Neutral
Berenberg - Initiated at Sell
Portales Partners - Sector Perform to Underperform
Nomura - Buy to Neutral
The analyst said JPM could find it difficult to "meaningfully improve" its return on equity in the future due to "higher-than-peer required capital buffers."
Mattress Firm (MFRM) posted revenue that rose 48.2% to $980 million but missed estimates for $1.0 billion. The company increased sales nearly 50% but was berated for missing estimates. Earnings of 57 cents also missed estimates for 65 cents. They opened 59 new stores and closed 49 stores bringing the total company operated stores to 3,482. They are being acquired by Steinhoff International for $64 or $3.8 billion including assumption of debt. That is the only reason the shares did not decline.
Crude prices have been very volatile the last several weeks. They have been buffeted by OPEC headlines claiming a production freeze was a possibility for several days and then no chance of a freeze for several days and then repeat. Prices have also been pushed around by the volatility in the dollar. A strong dollar means less dollars are needed to buy oil and a weak dollar sends oil prices higher.
The latest news on a potential freeze came from Russia and Saudi Arabia forming a joint venture to find a way to stabilize oil prices. In theory that means freezing or reducing production but in reality it was just one more headline that helped to support oil prices in September, a month that typically sees declines. The initial meeting of the two countries will be in October. If they were actually serious about stabilizing prices, they would meet immediately and announce a plan. This is just more headline spam to support prices in a weak period.
Active oil rigs rose +7 to 414 and gas rigs rose +4 to 92. Offshore rigs rebounded from the -10 the prior week with a +8 gain. This was related to the hurricane in the Gulf that shutdown 10-15% of the platforms along with those ten rigs.
The Gulf produces 20% of the U.S. crude and shutting down the platforms for several days was the reason oil inventories fell -14.5 million barrels last week. There was no monster surge in demand. It was simply a halt in production until the storm moved away. Anyone buying oil on that inventory headline has no clue how the sector works.
The consolidation pattern was broken by an abundance of events with the Rosengren speech getting the most blame. We will never know what actually triggered the strong selling but we were very overdue for a decline regardless of the reason. We sometimes forget that the market does not need a reason for a crash. Sometimes all the factors just line up at once and traders are caught off guard.
The strongest sectors over the last couple of weeks were the small and mid cap stocks. The biggest losses on Friday came from the small and mid cap stocks. No real surprise there. The Russell 2000 lost -3.1% while the Dow lost only -2.1%.
This was a good example of portfolio managers locking in profits ahead of 9/11 and the Fed meeting. I reported earlier, I saw some preliminary unexpected selling on Wed/Thr in stocks that had been strong gainers in past weeks. Suddenly they were down 2-3% on no news. This was the advance warning. That profit taking accelerated on Friday as the Fed fears escalated. Stops were hit and the selling became a cascade.
That means there was no material pause points. Every sharp intraday dip triggered new stop losses and new selling. The S&P closed at the low for the day.
The S&P crashed out of its recent congestion range and closed just below light support at 2,130. I do not expect it to rebound from that level. While the market crash could have been a one-day wonder, there should be more selling as a result of margin calls on Monday. There are three Fed speakers on Monday and Brainard speaks at 1:PM. I would not expect any material rebound until after her speech and then only if she remains dovish.
A continued decline would most likely stop in the 2100-2105 range. If that level breaks, we could be looking at 2,050 to 2,000. Given the strong volume on Friday and the 10:1 negative internals, there is a good chance the worst is over. That does not mean an immediate rebound but I would not expect any further "crashes" unless the Fed commentary turns even more hawkish.
All 30 Dow components were negative and 24 of them lost more than $1. Boeing and 3M were the biggest losers followed by HD, IBM, GS and UTX. There was no specific news on any of those stocks that would have caused them to decline -3% or more. This was simply more of the big cap weakness we have seen over the last several weeks. When the market decline accelerated the big caps were the first to be sold because they are the most liquid and the easiest place to raise a lot of cash quick. In times of market stress, sometimes you have to sell what you can instead of what you want to sell. For retail traders, selling the big caps raised cash to cover margin calls on stocks they wanted to keep.
The Dow has risk to 17,925-18,000 and we could easily see those levels on Monday if there is any follow through selling.
The Nasdaq was a wasteland on Friday. After setting a new high on Wednesday there was a minor drop on Thursday but the bottom fell out on Friday. The Nasdaq lost -133 points or 2.5%. The support at 5,200 was broken at the open and the continued decline was dramatic.
The 5,100 level is light support but there is a good chance we retest 5,000 on any multiday weakness. Any rebound will have a tough climb as traders exit along the way, thankful for the opportunity to recover some losses.
Note that almost all of the 30 biggest losers lost more than the top stock gained on the winners list. Only 12 Nasdaq stocks gained more than $1 and the 30th biggest gainer only added 29 cents.
The Russell 2000 fell right to the bottom of the uptrend channel and stopped exactly where we would have expected it to stop. Any further decline breaks the channel support again but the 1200-1205 level should be a pause point. A break below 1,200 turns a minor bout of profit taking into a rout and the 1,095 level comes back into focus.
Do not fight the Fed. If the Fed has decided they are going to hike rates in September regardless of the data, then get out of the way, because the market is going lower. I know it is irrational and a quarter point increase is nothing more than a mosquito bite in the long term scenario. It comes from decades of fearing a recession brought on by Fed rate hikes. The Fed has a gun with only 1 bullet. We are going to see a recession at some point in the next 18-24 months and the Fed is desperate to reload by adding some rate hikes to their arsenal. The higher the interest rate when we reach the next recession the more times they will be able to cut to slow those recessionary forces. They only have one bullet today and it is scaring them because they see the long-term outlook.
This economic expansion is now 7 years old and the third longest in history. The law of averages is working against the Fed and it is only a matter of time before trouble strikes. The sharp declines in the economic reports have awakened the Fed from its stimulus induced coma.
Monday's market will be driven by margin calls and Fed speeches. Brainard is the key to the Fed outlook. As the most dovish member of the group, if she changes her tone, look out below.
For the last couple of weeks, I have been warning to refrain from being overly long, keep some cash in reserve and make a shopping list of stocks you would like to buy on a dip. If you followed my recommendations, Friday was painful but not the end of the world. Now you have more cash to spend. Pull out that shopping list again, look at the charts and pick entry points that would be a best-case scenario. You never know when you will get that once in a year opportunity again.
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This will be an interesting week. The graphic below is for the survey week that ended on Wednesday. The Nasdaq and the small and mid caps were making new highs. Bearish sentiment was declining with the losses evenly split between the neutral and bullish groups.
The survey that ends next Wednesday is sure to be dramatically different depending on the next two days of trading and the Fedspeak on Monday.
Fifteen years ago today (9/10) my son and I had just completed a presentation in Washington and were scheduled to fly back to Denver the next morning. I had plenty of time we were bored so we went to the airport and flew standby back to Colorado that night. I woke up the next morning to planes where we might have been passengers, crashing into the World Trade Center. It was a sobering experience about how quickly and unexpectedly your life can be over. Never take any day for granted.
In July 2001, a writer for Option Investor had just written a commentary projecting seasonal market movements for the rest of the year. The next day he received a cryptic email from a reader warning "In early September every market in the world will crash. You can bet on it." The actual email was a little longer but that is all I can remember today. We discussed it at the time trying to decipher what could cause the worldwide markets to crash. We could not reach a consensus that made sense and forgot about the email as some crackpot conspiracy theorist. A couple weeks after 9/11 somebody remembered the email. It had been deleted and there was no way to trace it backwards. We get thousands of emails a day and back then, we did not archive them.
I have often thought about that email and wondered why a terrorist, knowing he was going to die in a couple months, would be reading an option investing newsletter. It came to me one day that it was probably not anybody on a plane but somebody farther up the supply chain that actually had investments. Somebody, supposedly Bin Laden, funded the $500,000 spent by the hijackers for room, board, transportation and training. We have readers all over the world and quite a few in the Middle East. Who knows, that person may still be reading the newsletter today.
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"A teacher is never a giver of truth; he is a guide, a pointer to the truth that each student must find for himself."