The disclosure by the FBI that they had discovered a laptop owned by Huma Abedin containing tens of thousands of State Dept emails was Kryptonite for the market and the indexes declined sharply.

Weekly Statistics

Friday Statistics

At 1:PM on Friday FBI Director Comey took the unusual step of notifying Congress that he was "supplementing" his testimony regarding Hillary Clinton's classified emails. Later reports said in an unrelated investigation they had discovered a device that contained emails from Clinton and the FBI would be investigating their potentially classified status. He did NOT say there were any classified emails on the device. However, given the timing of the letter to Congress, the impact on the political campaigns and the attention any further testimony would attract, it is probably safe to say these emails are not discussing yoga routines or Chelsea's wedding. Comey would not drop this bomb this late in the political campaign unless they already knew the details would be damaging. There is speculation that this laptop contained a backup of the 33,000 emails Clinton deleted.

The market was trading sideways on very thin volume when the headline appeared. There was an immediate decline that pushed all the indexes into negative territory.

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On the economic side the first reading on the Q3 GDP came in at +2.9% growth and much stronger than expected. The Atlanta Fed was predicting 2.1% and the analyst consensus was 2.5%. While the reporters are talking up the stronger than expected GDP, the facts tend to get in the way.

Inventories added 0.61% and exports 1.17% or more than half the headline number. Personal consumption, which normally accounts for more than 70% of the GDP fell to only half of the Q2 level. Consumers quit spending in Q3. Fixed investments otherwise known as capital spending, subtracted from growth for the fourth consecutive quarter. That has never been seen before outside a recession.

The real kicker is the export number which rose from $7 billion in Q2 to $49 billion in Q3. This was the highest level in more than two years. The number one export was soybeans, which normally are exported in Q4 but a poor harvest in South America pulled those exports into Q3. The Q4 export is such a regular event that the government adjusts Q4 numbers with a seasonal adjustment to "smooth" the Q4 GDP. Since the exports were pulled forward into Q3 by the weak harvest there will be a hole in Q4. The current seasonal adjustments for Q3 meant that food and beverage exports increased by +121% in Q3 and obviously not a repeatable number.

Using the Bureau of Economic Analysis numbers the $38 billion in one-time soybean exports was one third of the total $119 billion increase in Q3 GDP. That represents 0.9% of the 2.9% headline number. Capital Economics said if you remove the one time soybean exports, the inventory build, which will be negative in future quarters and the impact of Obamacare, which added 10% to Q3 GDP, the U.S. actually grew by only +0.9% in Q3.

We can expect to hear the politicians and the news sources bragging about 2.9% growth and the highest in more than two years BUT it is a bogus number that will be corrected over the next two quarters with abnormally low GDP reports. You cannot take one third of the GDP increase from one quarter and pull it forward without leaving a hole in the quarter to follow.

The Atlanta Fed GDP forecast remains the gold standard for predictions. Removing the 0.9% for the soybean exports gives a headline number of +2.0% and the GDPNow forecast was 2.1%. The average over the last four quarters is now +1.5% growth and far too low for the Fed to get excited about a series of rate hikes.

Consumer Sentiment for October fell to 87.2 and tied the lowest level since the 86.9 in October 2014. September 2015 saw the same 87.2 reading. That is a -4 point decline since last month and the largest one-month decline in more than a year. The present conditions component declined from 104.2 to 103.2 and the expectations component fell -5.9 points from 82.7 to 76.8. That should tell you something about how excited consumers are about the two presidential candidates. Respondents said the country's direction and outlook for business were the two main factors weighing on their sentiment. More than 30% of respondents said their financial conditions had worsened. More than 71% of those surveyed said business conditions would stagnate or worsen over the next year.

We have a big week ahead economically. The ISM Manufacturing Index on Tuesday is not expected to improve and there are whisper numbers for a decline. The ADP Employment report on Wednesday is expecting only a minor increase from the 154,000 new jobs in September.

The FOMC announcement on Wednesday is not going to feature a rate hike but the Fed is expected to begin warning about a hike in December. The election will be over and the Fed can hike another quarter point and then go to sleep for another six months. The December hike would be to save face since they have threatened a rate hike all year. For November, there is only a 9.3% chance according to the Fed Funds Futures. There is now a 74.2% chance for a hike in December and that is likely to rise after Wednesday.

However, Yellen has been making noises about letting the economy run hotter for longer before raising rates so the Fed guidance is going to be interesting. The economy is far from hot so longer could be a long time if she meant what she said. This is the same person that recently said the Fed could buy equities if their current QE actions were not enough to juice the economy. I would bet that comment did not go over well in the boardroom.

The last nugget next week will be the Nonfarm Payrolls on Friday. They are expected to increase from 156,000 to 170,000 but there are worries that we could see a decline instead. The regional economic numbers over the last six weeks have seen some employment declines. Whether that will carry over into the bigger market is unknown. The Fed should have these numbers before their Wednesday announcement and it could impact their decision.

Earnings remained the biggest news story of the morning and McKesson (MCK) was the disaster of the day. The drug distribution company reported earnings of $2.94 and missed estimates for $3.05. However, the big hit came from lowered guidance. The company lowered guidance for 2017 from $13.43-$13.93 to $12.35-$12.85. The CEO said we are starting to see competitive activity that is broader and more aggressive than previously thought.

There are more companies marketing competing biosimilar drugs and there is growing price pressures from the pharmacy companies. This will only get worse regardless of who wins the election. Clinton has vowed to lower drug prices and allow importation of similar drugs at a cheaper price. Trump has said he would change the laws to allow Medicare/Medicaid to negotiate prices. As the biggest purchasers of drugs that could lower prices significantly.

A lot of companies have drugs going off patent. An example is Amgen's Enbrel, a drug that accounted for 80% of the company's income growth. Unless companies have new blockbuster drugs in the pipeline, the loss of exclusivity on their top drugs is a serious problem.

McKesson shares were down over 25% at one point to $115 but rebounded slightly to close at $124 with a $36 loss. Competitors Cardinal Health (CAH) fell -10% and AmerisourceBergen (ABC) fell -13%. Amgen (AMGN) fell -10%. Cardinal Health reports earnings on Monday.

Novo Nordisk (NVO) reported earnings of 58 cents compared to estimates for 56 cents. Revenue was $4.13 billion. So far so good. Unfortunately, the company said the U.S. market has become "significantly more challenging" and it "no longer deems it achievable" to reach the operating profit growth target of 10% and they lowered it to 5%. They recently announced plans to lay off 1,000 workers to reduce costs in the U.S. market. Shares collapsed 13% on the lowered guidance.

The Healthcare sector is in crash and burn mode with a -2.2% decline on Friday alone to a 7-month low. I looked at buying the dip but we may be a week too early. I am recommending a play this weekend on the biotech sector.

Hershey (HSY) redeemed itself from the post buyout decline when they reported earnings of $1.29 that beat estimates for $1.18. Revenue of $2.0 billion barely beat estimates for $1.99 billion. They raised guidance for full year earnings from $4.24-$4.28 to $4.28-$4.32. Shares rallied 7% on the news.

Anheuser-Busch InBev (BUD) reported earnings that missed estimates for the sixth consecutive quarter. The company said beer sales in Brazil had fallen by 6.8% and there were cracks appearing in the U.S. craft beer boom. BUD is trying to buy up all the competition and spent $103 billion buying SABMiller Plc. The company slashed guidance saying it no longer expects to see volume growth outpace inflation. Q3 earnings rose 2% and analysts were expecting 4.5%.

Amazon (AMZN) reported earnings Thursday after the bell and missed estimates. The company reported 52 cents and well below the 78 cents analysts expected. Sales increased 29% to $32.7 billion and beat estimates slightly. To put this report in perspective they reported 17 cents and $25.36 billion in the year ago quarter. Amazon guided for Q4 for revenue in the $42.0-$45.5 billion range and earnings in the $0 to $1.25 billion range. That is the widest range I have ever seen for earnings guidance. Analysts are expecting earnings of $2.14 and revenue of $44.58 billion. Amazon will hire 120,000 temporary employees for the holiday season. The company ended the quarter with $12.52 billion in cash.

Amazon said Alexa, the voice of the Echo device, has received more than 250,000 marriage proposals to date. The company said they have some surprises in store for this year that will be a major improvement.

Amazon ended the quarter with 65 million Prime accounts based on analyst estimates. A Prime customer spends an average of $1,200 a year and more than twice the spending by a non-Prime customer. Having a lot of Prime customers is a double-edged sword. Amazon said shipping expenses rose 43% in Q3 to $3.9 billion and was responsible for part of the earnings miss.

Virtus Investment Partners (VRTS) reported earnings of $1.64 on revenue of $82.3 million. That beat estimates for $1.50. Shares spiked $20% on the news.

Chevron (CVX) reported earnings of 68 cents that beat estimates for 39 cents. However, Chevron does not adjust earnings for onetime events like asset sales so that is not really and apple to apples comparison. Revenue of $30.14 billion did beat estimates for $30.06 billion. Production averaged 2.51 million bpd, down from 2.54 million. They guided for Q4 production of 2.65-2.70 million boepd. Chevron raised its quarterly dividend by a penny to $1.08 per share. This is the 29th consecutive year they have raised the dividend. They reduced capex spending by $10 billion due to deliberate cut costs. Expectations were low for Chevron so shares rallied 4%.

Exxon (XOM) reported earnings of 63 cents of $2.65 billion, down from $1.01 and $4.24 billion in the year ago quarter. Revenue was $58.7 billion. Analysts were expecting 58 cents and $60.4 billion. Exxon cut capex spending by 45% to $4.2 billion. Production fell -3% to 3.8 million boepd.

Next week is the busiest week of the Q3 earnings cycle but the number of companies that can move the market is limited. Facebook, Alibaba and Starbucks are probably the top three investors will be watching. Now that we are past the blue chip reporting phase, the quality of earnings will decline along with the lack of big name companies.

GE and Baker Hughes (BHI) are talking merger. No, GE is not likely to buy BHI but there is a good chance they will do a joint venture or GE will sell its oil servicing assets to BHI. The energy division was a big drag on GE earnings last quarter and GE is interested to doing something about that. Reportedly, GE approached BHI and a spokesman said we are talking about several options but "none of these options include an outright purchase" of BHI.

If GE sold its energy servicing business to BHI it would lift the company to the number two in the sector behind Schlumberger's $28 billion in revenue. It would catapult BHI from $11 billion in revenue to $22 billion. GE has decided the energy business is too cyclical and they would rather focus on manufacturing equipment rather than maintaining it. Since GE has recently added to its energy services division, ($3.4 billion purchase of Lufkin in 2013) they are probably not going to get a cash bid from BHI that would make them whole. If BHI gave them stock, GE would have a longer-term potential to make a profit once energy prices recovered.

The Volatility Index ($VIX) rose all week but still spiked 3.5 points intraday after the FBI news broke. Apparently, that encouraged a lot of traders to start buying protection.

There are currently 7 times more call options on the VIX than put options. That is the highest since August 2015 just before China devalued the yuan. Clearly, there are a lot of investors either betting on a crash or hedging against a crash.

Seven fund managers reported a total of $50 billion in net outflows in Q3. The biggest losers were Franklin Resources at $22.1 billion, AllianceBernstein with $15.3 billion and Waddell & Reed Financial at $4.9 billion. Others with outflows included T Rowe Price, Ameriprise Financial, Janus Capital and Legg Mason. In Q2, the same 7 funds saw outflows of $34 billion. The reason for the constant stream of outflows from actively managed funds is the shift to passive funds and ETFs. Actively managed funds have had a poor track record over the last couple of years and investors are leaving in droves. Waddell & Reed marked the 9th quarter of outflows. Fewer than 15% of actively managed funds have beaten the S&P-500 over the last 10 years according to S&P Global.

In the 12 months ended September 30th, actively managed funds had outflows of $295 billion. Passive funds had inflows of $454 billion. BlackRock saw inflows of $55 billion in Q3 with 90% going into ETFs. Vanguard Group saw inflows of $78 billion into index funds and ETFs. There were 8,044 ETFs at the end of 2015 with $2.5 trillion invested.

Oil prices are sliding lower as the outlook fades for an OPEC production cut. The delegates to a two-day meeting in Vienna said on Friday they had not reached a consensus on quotas after the first day. Iran, Iraq, Libya and Nigera have claimed they should be exempt from any output cuts. None of the countries attending specified how much they would be willing to cut to stabilize prices. Non OPEC producers Russia and Brazil joined the talks on Saturday. Russia's energy minister was quoted as saying, why do it, "any output freeze could be offset by a quick recovery in US shale output."

After the informal agreement in Algeria, OPEC said it was going to shoot for a reduction in production from 33.4 mbpd in September to 32.5 to 33.0 mbpd when they met at the end of November. The tricky part was deciding how much each country would have to cut production to meet that goal. One delegate said, "It is getting complicated...every day there is a new issue coming up."

The joke making the rounds is that OPEC now means "Organization of Producers Exempt from Cuts." Even if they do claim to have an agreement when they meet in late November, the odds are close to 100% that nobody will honor it. OPEC countries have never honored any prior agreements so why start now. It is all a show for the rest of the world as they try to talk up prices.

Crude prices declined more than 2% on Friday as the news trickled out of Vienna. While very few professional market watchers ever believed OPEC could pull off a production cut, now it appears they may not even be able to enforce a production freeze. Getting everyone to agree is nearly impossible. Getting them to comply is impossible.

The U.S. added 4 active rigs last week but that is not the real story. There were 6 new gas rigs while oil rigs declined by two. The recent spike in gas prices has motivated gas producers and they have added 20 rigs since early September. At the same time, 36 oil rigs have been reactivated. We still have only 25% of the rigs that were active at the peak in 2015.

The dollar index gave back 50 cents on Friday with the majority of that on the dip caused by the FBI headlines. The strength in the dollar has made it very hard for commodities to rise and kept the pressure on crude prices. Meanwhile gold prices rallied after the headline to close at $1,276 and a four-week high.




The normal historical trend for a rebound in the last two weeks of October has failed. The election uncertainty has smothered any positive sentiment that actually existed. The Dow is trapped in a tight range but the S&P, Russell 2000 and S&P-600 are all weak.

The FBI announcement at 1:PM on Friday killed what little bullish sentiment still existed. The major indexes fell to the lows of the day and the Dow is the only one that tried to recover.

The S&P has support at 2,120 and the intraday dip knocked it down to 2,119.36 before a minor rebound. The 2,120 support level is critical. We had been fighting the 2,145 resistance for most of the week with minimally lower highs every day. The close on Friday under 2,130 was seen by some as a bearish event because it was the second close under that level since September 14th. The 2,126.14 close was exactly the same close as October 17th and that is a six-week closing low. If the S&P weakens to close under 2,120 we could be in a world of trouble.

The Dow suffered under the earnings curse last week with some companies beating estimates and spiking and others missing and falling. After all the smoke cleared, the Dow actually gained 15 points for the week. However, it remains locked in the 18,100 to 18,250 range and this week there are no Dow stocks reporting earnings. The index will be left to find its own direction and with 26 Dow stocks already reported, all of them will be experiencing post earnings depression.

The Dow will be driven by the external headline from the political campaign, Fed meeting and the payroll reports. None of those events are expected to give a material boost to sentiment. The biggest risk is a decline under that 18,100 support to trigger sell stops and fall into that empty void on the chart with 17,135 at the bottom.

On the positive side, the Dow has not sold off. It has had multiple chances over the last couple of weeks and has always honored that support at 18,100 by the close.

The Nasdaq Composite closed 10 points under critical support at 5,200 but still close enough for it to be in play. Any further decline targets 5,100 and the lows from September.

The Nasdaq 100 ($NDX) made a new high on Monday and fell all the way back to support at 4,800 on Friday. I said multiple times I thought fund managers would buy big cap tech stocks to window dress for the end of October but it did not happen. They were off to a good start on Monday but the negativity and the election uncertainty apparently kept them in cash. A break below 4,800 targets 4700-4650.

The bad news for the week came from the small cap indexes. The Russell 2000 closed at nearly a 4-month low on Friday and well under the last material support at 1,200. There is nothing under Friday's close until the 1,100 range.

The S&P-600 small cap index is almost identical to the Russell with a nearly 4-month low and totally unsupported at this level.

The breakdown in the small caps suggests the broader market is likely to decline. The small caps normally lead in both directions and with the big cap buying fading as we enter November, the outlook on a technical basis is negative.

We could wake up Monday to a completely new spin on the election and the FBI headlines. I have read dozens of articles this weekend with a couple claiming the FBI is not even in possession of the emails because they did not have a warrant to seize that data since their warrant only covered the sexting case. Whether that is true or not remains to be seen. It is entirely possible those emails could disappear by Monday and all the momentum shift back to Clinton. I think that would cause a significant amount of frustration for at least half the population but this is a crazy year.

Given the polarization between the political parties and the short time left in the race, we could still see several other bombshells between now and Election Day. The outcome is far from decided and that uncertainty could cause significant market volatility. Once we are in November, the fund managers no longer have to be fully invested and they can dump positions in volume ahead of the election with plans to reinvest once they see who wins and which sectors will benefit. That could increase any volatility in a thin market.

I would continue to caution against being overly long and I would suggest you update your shopping list of stocks you would like to buy on a dip. Your prior selections may have changed.

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Random Thoughts

There is still a tug of war in progress between the bulls and bears and several ended up in the neutral camp this week. This survey ends on Wednesday so the events of Thr/Fri are not yet included.

When Alphabet (GOOGL) reported earnings, they also announced a $7,019,340,976.83 stock buyback. Alphabet is famous for announcing deals with some hidden meaning in the number and they do not tell us the meaning. You may remember their first buyback program was for $5,099,019,513.59 in 2015. After a few hours, some enterprising math researchers came up with the answer. There are 26 letters in the alphabet and that is the square root of 26.

The puzzle this year was quickly deciphered by a retired math teacher named John Owens. 7019.34097683 = 26^e. "e" is a constant in math and physics. That is far above my pay grade.

Professor Jeremy Siegel has been one of the biggest bulls on Wall Street with a 2,300 price target on the S&P. On Friday, he backed off on that prediction but only by a little bit. Now he believes the S&P will close between 2,250 and 2,300. He is blaming the election uncertainty, the possibility of a Fed rate hike and weak earnings guidance for the minimal reduction in his target.

He said we would need "bang up earnings and super guidance" to get over the hump of a rising 10-year treasury yield. He said even though everyone now expects the Fed to hike in December, the real worry is how often the Fed will hike in 2017. The 10-year treasury yield was up over 5% for the week.

Walmart is upgrading the customer experience this holiday season. They are doubling the number of product demonstrations to 150,000. They are hiring a dedicated pickup manager for each store for people that order online and want to pick up at the store. The manager will have a very high profile counter painted bright orange to make it easier to find and to advertise the pickup option. The store has increased the number of items available online from 8 million to 20 million.

Santa Claus will live in each store with "selfie booths" where customers can take their own pictures with Santa. Walmart will offer 400 toys that are not available anywhere else. One example is the $398 Disney Princess Carriage that is already sold out online, but they have ordered more.


Enter passively and exit aggressively!

Jim Brown

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