The markets lost some ground for the week but missed a good opportunity for a real decline.

Weekly Statistics

Friday Statistics

The markets attempted to decline all week with lower highs and lower lows but every minor dip was bought and while the indexes did post a loss for the week it was minimal. Critical support held on the Dow at 20,800 and S&P 2,360 and the Friday rebound kept the weekly losses at a minimum.

With nearly everyone expecting at least a minor sell off you would think there would be no buyers. Apparently, there is also a significant lack of motivated sellers and just enough buyers to keep the losses to a minimum.

The big economic event on Friday was the Nonfarm Payrolls for February. The headline number of 235,000 easily beat upwardly revised estimates for 190,000. The January total was revised higher from 227,000 to 238,000 and the December total was revised lower by 2,000 jobs to 155,000.

The manufacturing and construction sectors were big winners thanks to the warmer weather in February. Goods producing sectors saw jobs rise 95,000 with service sectors rising 140,000. Of the 235,000 jobs, 227,000 were private jobs and 8,000 were governmental.

The construction sector added 58,000 jobs, leisure & hospitality 26,000, healthcare 27,000, manufacturers 28,000, mining/energy 9,000 and financial services 7,000. Retail was the big loser with a loss of 26,000 jobs as retailers close stores and layoff the remaining holiday workers.

Average hourly earnings rose +0.2% to 2.8% YoY. The unemployment rate declined from 4.8% to 4.7%. The broader U6 rate declined to 9.2%.

The labor force increased by 340,000 and the labor force participation rate rose one tenth to 63%.

The ADP report on Wednesday showed a gain of 298,000 compared to estimates for 190,000 and the second blowout in a row. The prior month showed a gain of 261,000 jobs.

I wrote last Sunday when estimates for both reports were 175,000 that I would be surprised if the actual numbers were not over 200,000. I guess my analysis was better than the people that get paid to study payroll reports.

The blowout jobs numbers cemented the chances for a Fed rate hike next Wednesday. At the close on Friday, the CME FedWatch Tool showed an 88.6% chance of a quarter-point rate hike. There was actually some talk of a half point hike but you can see on the chart below there is zero chance of more than a quarter point. The real risk is that economy continues to grow and the Fed accelerates their pace. Current estimates are for June and December with a potential balance sheet reduction announcement next March.

Currently the median expectations for all the FOMC participants is 1.25% for the end of 2017. That rises to 1.75% for 2018 and 2.5% for 2019. We will get a new Dot Plot after Wednesday's Fed announcement. If this has changed significantly, it would be market negative. The market wants to see a slow and steady pace and no acceleration. The Dot Plot is a significant help to the market in forecasting future rates.

The economic calendar for next week is very busy. The high points are of course the Fed announcement and the expiration of the debt ceiling. In October 2015, congress elected to avoid another contentious battle and just suspended the debt ceiling until a new president was elected. That suspension expires on March 15th. If a new deal is not reached by March 31st, the government will have to stop paying some bills and prioritize the payments on the debt to protect the country's credit rating. Treasury Secretary Steven Mnuchin has said that Treasury debt payments are a "critical commitment." The head of Office of Management and Budget, Mick Mulvaney, has questioned the urgency of raising the debt limit and has supported prioritizing debt payments over other obligations. After March 31st, the government will have to evoke "extraordinary measures" to allow the government to continue operating. That means things like contributions to federal retirement accounts will stop as well as other nonessential functions. That would allow the government to continue operating until September. However, once the debt ceiling suspension expires, it will become a daily topic on the nightly news and that could weigh on the market.

There is also a flurry of events outside the U.S. this week starting with Mario Draghi's speech on Monday. The Dutch election is on Wednesday with the far right anti-Islam populist, Geert Wilders, is in a dead heat with the current prime minister Mark Rutte. If Wilders wins, it would be another blow against liberal Europe. Wilders has pledged to close the Netherland's borders, shut down the mosques and leave the Euro and EU. Some analysts believe he has an 80% chance to win even though the actual polls are neck and neck. Pollsters believe voters for Wilders are afraid to say they are voting for him so his polls are artificially low. Wilders claims he is part of a growing worldwide movement and he speaks for the will of the people. That sounds eerily familiar to our recent election in the USA. If he wins, he would still have to build a coalition in a highly fractured parliament.

On Thursday the Swiss Central Bank, Bank of England and the Bank of Japan will all update their monetary policy so this will be a big day for the global markets.

In stock news, Sears Holdings (SHLD) reported an adjusted loss of $1.28 that was better than expectations for a loss of $2.85 per share. That still represented a loss of $607 million and they are burning cash at an alarming rate. Analysts believe they need $2 billion to make it through 2017. Revenue was $6.1 billion, down from $7.3 billion but beat estimates for $5.9 billion.

Susquehanna said Sears is struggling just to exist and the results were terrible. They do believe the chain will continue to exist through 2017 thanks to sales of real estate and brands, and then the outlook becomes increasingly worse once there are no longer any assets to sell. By selling their real estate and leasing it back, they raise immediate cash but they take on a new debt on every store. Outstanding debt and capital lease obligations rose from $2.2 billion to $4.2 billion in 2016. That means their cash burn in 2017 will actually increase significantly.

The company said it had completed the sale of Craftsman to Stanley Black & Decker (SWK) for an upfront cash payment of $525 million. That buys them another quarter of cash burn.

Shares spiked 15% on short covering, because nobody in their right mind would buy Sears for an investment. Time to get short again.

Finisar (FNSR) reported earnings of 59 cents on revenue of $380.6 million. Analysts were expecting 62 cents on revenue of $389.7 million. The company guided for earnings of 50-60 cents for Q1 on revenue of $360-$380 million. Analysts were expecting 58 cents and $393.1 million. The company said they were seeing a slowdown of demand in China in what could be the result of a weakening economy. China has been a large part of demand for networking manufacturers over the last year as they build out their 4G networks. If that demand is slowing it means other vendors will also have earnings problems.

Ulta Beauty (ULTA) exploded higher on Friday after reporting earnings of $2.24 compared to estimates for $2.13. Revenue of $1.58 billion also beat estimates for $1.54 billion. They guided for the current quarter to revenue of $1.24-$1.26 billion and analysts were expecting $1.28 billion. The weak guidance did not seem to matter to investors.

Vail Resorts (MTN) reported earnings of $3.63 and analysts were expecting $3.45. Revenue of $725.9 million also beat estimates for $709.3 million. Earnings and revenue have been growing as they continue to acquire other ski areas and then cross-market to their fan base. They recently bought Whistler Blackcomb in British Columbia. They announced last month they were acquiring Stowe Mountain in Vermont. Total lift revenue rose 25% to $358.2 million. Their results were even more surprising since the winter conditions early in the season were below average and slower to build a snow base. The more ski locations they add, the more the season pass becomes attractive for skiers that are interested in traveling to multiple locations. This means the higher end season passes will sell better. The company announced a new quarterly dividend of $1.053 per share.

Q4 earnings growth appears to have topped out at 4.9% but that is the first time we have had two consecutive quarters of growth since Q1-2015. With 99% of the S&P reported, 78 companies have issued negative guidance and 30 have issued positive guidance. More than 65% of companies beat the earnings estimates but only 53% beat on revenue. The 12-month forward PE is now 17.7 and above the 5-year average of 15.0 and the 10-year average of 13.9.

Earnings are over. There are a few stragglers but only a couple where you would recognize the symbols. Oracle and Adobe are the highlights for the week and the first couple days are devoid of anything material.

Ionis Pharmaceuticals (IONS) was cut from neutral to sell by Goldman saying the shares were overpriced and could fall by 45%. The company just got a drug approved with partner Biogen (BIIB) called Spinraza for spinal muscular atrophy. They also reported positive phase III results on Volanesorsen for familial chylomicronemia syndrome and they are applying for FDA approval. Goldman did not feel this drug would be a big winner. Ionis is planning on adding five new drug candidates to its pipeline in 2017. Shares fell -9% on the downgrade.

Snap Inc (SNAP) continued its decline after Facebook announced its third Snapchat clone called Messenger Day. It runs on Messenger and allows you to take a photo of yourself or surroundings, draw on it, add a filter or special effect, and then post it like a status update. It will be viewable by your friends for only 24 hours. Facebook already debuted Instagram Stories and WhatsApp Status, two other clones of SnapChat. Shortly after the Instagram Stories was announced more than 150 million had been posted. Since Messenger already has more than 1 billion users, adding the SnapChat like feature means those 1 billion users will not need to download another app just to accomplish the same thing. SNAP is not expected to be profitable for at least a year, if ever. The insider lockup period was changed to 150 days from the IPO date. Currently there are 660 million shares but only 150 million are available for trading. By the end of 2017 there will be 1.5 billion shares trading due to an aggressive stock-based compensation program and expiring lockups. By Friday, the short interest had already grown to 4.4% in only four days the stock has been available to short. Since it is not going into the indexes until at least six months, if at all because of the nonvoting stock, there is going to be a lot of selling interest and very little buying interest.

Options were listed on Friday and will be available for trading on Monday.

Incyte Corp (INCY) spiked 8% on Friday after a rumor broke it was nearing a deal to be acquired by Gilead Sciences (GILD). Incyte's Jakafi drug for myelofibrosis could give Gilead a starting point for cancer immunotherapy. If Gilead makes a deal for INCY then Tesaro (TSRO) could decline because it was also seen as potential acquisition target for Gilead. Shares have been declining for the last two weeks. Gilead shares have been declining for the last year because their drug sales for Hep-C are declining and investors were worried they would make a stupid acquisition.

Citigroup (C) said they were still buyers of Nvidia. They restated all the various sectors where Nvidia is either dominant or becoming dominant including AI, machine learning, automotive, IoT, gaming and multiple cloud partnerships. They just announced a joint venture with Microsoft where it will offer the HGX-1 Hyperscale GPU, which it bills as an "industry standard hyperscale GPU accelerator." The GPU is built from an open-source design Nvidia and Microsoft developed as part of the Project Olympus initiative and part of the Open Compute Project consortium. The head of Microsoft's Azure cloud platform said, "The HGX-1 AI accelerator provides extreme performance scalability to meet the demanding requirements of fast-growing machine learning workloads, and its unique design allows it to be easily adopted into existing data centers around the world."

I have said it over and over again, Nvidia is the bleeding edge of chip technology today. I believe Citi's price target is $145.

STM Micro (STM) reported a small fire in the basement of a manufacturing facility in France. This is the facility that makes the 3D motion sensors for the iPhone 8. The sensor manufacturing process is time consuming and the yields are very low. That means they can only make a limited quantity at a time. The delay from the fire could set production back weeks or even longer since the clean room above the fire has to be cleaned of smoke and recertified before production can resume. Apple engineers are on the site trying to get an idea how long the production process is going to be offline and whether Apple will have to change the anticipated delivery date of the new phones. This is the only facility that makes that sensor so Apple cannot just offload the order to somebody else. If the phone delivery date was pushed back a month because of the problem, it could disrupt earnings expectations for Apple for Q4. That would be a monumental event given the ramp in Apple shares on those expectations. Expect to hear more about this in the weeks ahead.

S&P announced another flurry of changes to the S&P indexes. These will take effect on Monday March 20th. The one stock most likely to benefit should be AMD going into the S&P-500. The stock is heavily shorted, has been a recent favorite and will require a lot of buying to bulk it up into S&P-500 portfolios. The stocks coming out of the S&P-500 could see some decent selling.

S&P-500 large cap:
In = Advanced Micro (AMD), Raymond James (RJF) and Alexandria Real Estate Equities (ARE).
Out = Frontier Communications (FTR), First Solar (FSLR), Urban Outfitters (URBN).

S&P-400 midcap:
In = Take-Two (TTWO), Masimo (MASI) and Coherent (COHR), Frontier Communications (FTR), First Solar (FSLR), Urban Outfitters (URBN).
Out = Advanced Micro (AMD), Raymond James (RJF) and Alexandria Real Estate Equities (ARE), Fossil (FOSL), Denbury Resources (DNR), Vista Outdoor (VSTO).

S&P-600 small cap:
In = Fossil (FOSL), Denbury Resources (DNR), Vista Outdoor (VSTO).
Out = Take-Two (TTWO), Masimo (MASI) and Coherent (COHR).

Crude prices crashed to the low for the year at $48.39 and the lowest level since November 30th. Prices fell -9% in three days to knock energy equities to the lowest levels since November. The problem boils down to inventories and production. Inventories rose to a new record high with the addition of 8.2 million barrels. Most of the oil producers met at CERAWeek in Houston last week and investors did not get any clues suggesting OPEC would extend their production cuts past June. Since Saudi Arabia has to increase production by 1.0 mbpd in the summer and burn the extra oil to generate electricity, it would be hard to say we are extending the cuts and then boost production by 1.0 mbpd. I am not expecting an extension.

U.S. production rose again to 9.09 mbpd and the highest level since last May as the shale fields came alive with new activity. The more than 5,000 drilled and uncompleted wells from 2016 are rapidly being completed and put into production and we could see another 500,000 bpd increase by the end of 2017.

Lastly, the net long open interest in crude futures was near record highs on the hopes the OPEC production cut would cause prices to continue to rise. When that did not happen, they have been stuck between $52-$55 for two-months, and OPEC oil ministers in Houston did not telegraph any extended cut, the fire alarm rang and everyone rushed to the exits at once.

Over the last 9 weeks, U.S. inventories have risen nearly 50 million barrels. While this may seem alarming, it is not. It is only alarming to uneducated traders. Inventories rise in Jan/Feb/Mar because refiners are taken offline for maintenance while fuel demand is low. This reduces oil demand by as much as 2.0 mbpd during that period. By the end of March, refiners are coming back online and they will begin producing summer blend fuels in high quantity. They have to let the winter blend fuels deplete and as you can see in the graphic below that is exactly what is happening. Once they move back into production, oil supplies will begin to fall and fuel inventories will begin to rise. They have to be in full production well ahead of Memorial Day and the unofficial start of the summer driving season.

Oil prices crashing in Feb/Mar is a good thing because it gives us a buying opportunity for energy equities. Oil prices typically peak around August ahead of Labor Day and the end of driving season.

Yellow is a recent low and green a recent high.

Active rigs rose by 12 last week to 768 with oil rigs up +8 to 617 and gas rigs adding 5 to 151. Even the offshore rig count rose +2 to 20. Since the low at 404 onshore rigs last May we have added 364 and almost doubled. By this May I am certain we will have double the active rig count over last year.




The markets missed a good chance for a decent bout of profit taking last week but that does not mean they will not get another chance in the coming week. The Fed statement is always a challenge. Traders worry about what they might say and then wonder what they worried about when the statement actually appears.

Do not forget the Tuesday before a Fed announcement is normally positive. Since that trend is so well known, I would not be surprised to see Monday positive as well. The Fed statement typically produces some immediate volatility but the initial direction after the release is seldom the one that sticks. The March meeting has a Yellen press conference at 2:30 so that is another opportunity for the Fed to calm markets if the statement was hawkish or to stir them up if she thinks the market did not react as expected.

Typically, Yellen is seen as the queen of the doves and even when she is trying to be hawkish, it seldom comes across as she expects.

The bigger problems will be the debt ceiling and the central bank statements from overseas. The BoE and BoJ would be the ones to watch. Since their statements come after the Fed policy statement, I would expect them to follow in the same line of thinking. They will not normally want to deviate significantly from the Fed's path.

Overall, the various indexes saw support tested on Thursday and there was a minor rebound on Friday. After six days of declines there were some oversold pressures starting to build. Friday's afternoon rebound was an equalization of those pressures as shorts took profits and covered ahead of the weekend event risk.

The S&P tested 2,360 on Thursday and closed 12 points above that level on Friday. Uptrend support has now reached that 2,360 level so it should have increased strength next week.

As of Friday, the S&P has traded for 103 sessions without a 1% market drop.

The Dow saw 20,800 tested and it held but the rebound was lackluster and the 20,902 close was not really out of trouble. At one point last week the Dow had erased the post speech gains but it recovered to end with a loss for the week of only 102 points.

The 20,800 level should remain support with uptrend support at 20,700.

The Nasdaq remains the market leader with the Nasdaq 100 spiking on Friday to close only 5 points below a new high. The big caps are rising and Google (GOOGL) set a new high close at $861 and Facebook at $138.79. Amazon missed a new high close by $4.

The Nasdaq Composite closed at a 5-day high at 5,861 but failed to really move out of the congestion range from the prior three weeks. Support at 5,800 was not tested but the Thursday drop to 5,812 came close. This level should continue to provide support unless there is a significantly negative headline. The historic high close was 5,904.

The S&P-600 small cap index declined to roughly 825.50 on each of the last two days with the 825 level strong support. Clearly, there were some buyers waiting but the rebound was lifeless and without a sudden change in sentiment, I would expect that 825 level to be tested again and probably with a little more volume.

With the multiple major events next week, this could be a volatile period for the markets. However, they like to climb a wall of worry and this week would qualify.

We saw a decent support test and a mediocre rebound that suggests we could see another support test. Our four-leaf clover for next week is the tendency for the markets to rally on the Tuesday before the Fed announcement. That could be the slight bullish bias we need to avoid an early week retest.

Random Thoughts

There was a major change in sentiment last week. Bearish sentiment jumped a whopping 10.9% and bullish sentiment fell -7.9%. You would think there had been a market crash instead of just several days of breakeven trading. That is the highest level of bearish sentiment since February 2016 at 48.7%. On a contrarian basis the S&P is typically up 5.8% six months after a high in bearish sentiment. The only question is whether or not this is the high.

Last week results

Late Friday the SEC denied a request by Cameron and Tyler Winklevoss to list a Bitcoin ETF for trading on the Bats exchange. Bitcoin's value had risen to $1,325 early Friday afternoon on hopes the SEC would approve the request. Immediately after the SEC ruling, the Bitcoin Price Index declined to $1,022. The SEC said based on Bitcoin's record of cyber security breaches and the lack of consistent treatment of the assets by governments, we believe the Bitcoin market is unregulated and not ready to be publicly traded in an ETF. They said over time, markets of significant size may develop and they could look at it again when that occurred.

There are two other applications pending from the Bitcoin Investment Trust and SolidX Partners, a blockchain services company.

Twitter claims to have 319 million monthly active users. However, researchers at USC claim as many as 48 million may be robots. They used more than 1,000 features to identify robot accounts and determined that between 9% and 15% of Twitter accounts are actually robot accounts. Twitter had previously said they thought 8.5 million accounts were machines. Not all robot accounts are bad. Robots can notify people of disasters by reading the tweet stream and analyzing the data. By screening the data stream, only the tweets that have data deemed useful to the actual user makes it through to the user or a distribution list.

However, some robots are negative. They can look for tweets and content that has a specific political perspective and then blast it out to hundreds or thousands of other news feeds to make sure the information is widely disseminated. Some emulate human behavior to manufacture fake grass roots support, promote terrorist propaganda or recruitment. If robots can now tell us what to think, can even more significant machine control be on the horizon?

Since January 4th, the high on the Volatility Index (VIX) has been 13.28. That is the longest period of low volatility since the financial crisis. This suggests total complacency and on a contrarian basis, extreme market risk. The VIX has gone through 46 sessions as of Friday without breaking 13.5. The last time this happened began in September 2006 and ran for 112 days. The VIX can remain low for a long time but the longer the period of relative calm, the worse the correction at the end.


Enter passively and exit aggressively!

Jim Brown

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