The trend is your friend until it ends and Tuesday was definitely a change in that direction.
The change in direction was blamed on at least a dozen different things but it may have just been time for a pause. I wrote several times recently that the three weeks after March option expiration were typically rocky. The Q1 option cycle is over, Q4 earnings are over and the tax payment deadline is only three weeks away. Traders have to look at their portfolio, cash on hand and anticipated tax due and make decisions on how to handle that problem. This is the perfect time for changes since the Q1 earnings cycle does not start for three more weeks. The Fed is behind us and there are no catalysts in the market that require an urgent investment. This is why this three-week period is typically rocky.
This year there are other problems for equities. The Trump honeymoon is coming to a rapid end with the healthcare train wreck in the House. After several weeks of haggling and arm-twisting, the bill is all but dead. In the republican side of the House, there are 136 supporters, 52 undecided and 48 opposed or seriously concerned according to one survey. Late in the afternoon the Conservative Caucus reportedly had 25 hard line no votes and 2 leaning to a hard no. That is the death knell for the bill because the republicans can only afford to lose 21 votes and still get it passed. The odds are nearly 100% that the bill will be pulled rather than go up for a vote on Thursday. There is no chance for passage in the Senate regardless of the outcome in the House.
This is rapidly being seen as the wheels falling off the Trump train. If the republicans are too fractured to get a healthcare bill passed then they will have no chance getting a major tax overhaul completed, major deregulation accomplished and almost anything else on the agenda. This is a political disaster for the Trump policy plans.
Adding to the problem were comments from House Ways and Means committee Chairman, Rep Kevin Brady, that a border tax is a given. That happened just before the open and that caused a significant ripple when the markets began trading. Retailers of all types sold off hard because of the significant hike in prices they would face.
The small cap stocks sold off hard because they would benefit the most from the Trump policies and with those policies suddenly in serious doubt, the small cap stocks imploded. The Russell 2000 lost -2.7% or a whopping -37 points to close just over critical support at 1,340. The S&P-600 closed at a 4-month low at 822 and just under support at 825. This is a major breakdown and any further declines could trigger a broader market selloff.
There were no economic reports to move the market. The Current Account Deficit was nearly unchanged from the last update at -$112.4 billion for Q4. This was old news and ignored by the market. State and local tax revenues increased slightly from 1.4% to 1.6% in Q4. This was also ignored since we already at the end of Q3.
The only material report on the calendar for Wednesday is the Existing Home Sales for February. Expectations are for a slight decline to 5.59 million. On Wednesday, Yellen speaks again but she is not expected to move the markets. If anything, she will just repeat the key points from the press conference last week.
There are plenty of other Fed speakers over the next two days and they will spin their own views of the economy and rates.
Two other indicators have been suggesting for the last week there was trouble ahead for equities. The bond yields began to fall despite the Fed's rate hike. Investors seeing the train wreck in Washington began to hedge their equity bets last week by increasing bond positions.
The dollar began to decline after the Fed meeting and Dutch election outcome. When the anti-EU candidate lost, the Euro strengthened. When the anti-EU candidate did poorly in the French debate, the Euro eased up slightly once again.
The rising Euro will be beneficial for Europe but it will make it tougher for U.S. companies to sell goods overseas.
The falling dollar should be lifting crude prices but oil fell another $1 to a four month closing low on worries about demand, inventories and over production. This break of support at $48.50 suggests there could be lower lows ahead. This caused energy equities to decline again and helped to weaken the overall market.
The border tax comments from Rep Brady crushed retailers and Under Armour (UA) was the biggest decliner on the S&P with a 4% drop. This was a new historic low close. Macy's (M) closed at a five-year low. Target (TGT) also closed at a five year low.
This is not going to be a temporary dip. If the border tax is a done deal, we are going to see a lot of disruption in the retail market on nearly every item from shoes, clothes, food, auto parts, gasoline prices, sporting goods, etc. This will change the entire scope of the retail sector and there will be many stores that go out of business because they cannot compete with the scope of a store like Walmart.
Before the bell homebuilder Lennar Corp (LEN) reported earnings of 59 cents compared to estimates for 56 cents. Revenue of $2.34 billion also beat estimates for $2.17 billion. The company said it was riding a wave of economic optimism and buyer confidence. The company said the supply of previously own homes was the tightest they had ever seen.
New orders rose 12% and beat estimates for 7.7%. They delivered 5,452 homes in the quarter, up 13% with gross margins of 21.1%. That was below the estimates for 22.3% and shares declined after the report despite the outstanding quarter.
After the bell Dow component Nike (NKE) reported earnings of 68 cents that beat estimates for 53 cents. Revenue of $8.43 billion missed estimates for $8.47 billion. Gross margin fell 140 basis points to 44.5% due to higher selling costs and strong dollar issues. Nike brand revenues rose 7% to $7.9 billion on a constant dollar basis thanks to double-digit growth in Western Europe, Greater China and emerging markets. Revenues for Converse rose 3% to $498 million.
They repurchased $475 million in shares as part of their 4-year $12 billion program of which $8.4 billion remains open. They ended the quarter with $6.2 billion in cash. Inventory levels rose 7% after a similar gain in Q3. This suggests the sell through is not working as well as expected.
Nike is facing a lot of competition from Adidas and Under Armour. Shorts on Nike are over $2 billion for the first time ever. Shares fell -4% in afterhours.
FedEx (FDX) reported earnings of $2.35 that missed estimates for $2.62. Revenue of $15 billion matched estimates. They shipped a record number of packages in Q4. Operating profit margin was 7.5%, down from 9.2%. Margin on the ground segment fell from 12.6% to 11%. The company reaffirmed full year guidance for earnings of $10.80 to $11.30.
FedEx said a major increase in fuel prices in Q4 depressed profits. FedEx Freight saw a drop of 27% in operating income and the company was targeting double digit growth. Shares fell -$7 in afterhours.
Disney (DIS) shares were upgraded after the monster $170 million opening weekend take by Beauty and the Beast. Multiple analysts reiterated buys saying this is why you always want to own Disney. They are capable of producing blockbuster movies one after the other. Nomura raised estimates to $125 and Instinet matched that move as well. With the success of the live action Beast, they still have 11 other classics in the process of being remade into live action movies or in the case of Mary Poppins, a live action sequel. Those are Mulan, Aladdin, Lion King, 101 Dalmatians, Little Mermaid, Pinocchio, Sword in the Stone, Peter Pan, Snow White and the Seven Dwarfs, Dumbo and the sequel to Marry Poppins.
Facebook was upgraded by BTIG to a buy with a $175 price target. The analyst said he was wrong when he downgraded them last year after they warned they would spend more money. Now he is upgrading because they are revolutionizing their business and the decline in profits never appeared. He said the new Instagram Stories feature had taken off and was extremely popular. Also, their new handling of video is also compelling. He thinks ad revenue will rise sharply.
Apple (AAPL) announced the new iPhone 7 and 7+ in the (PRODUCT)RED Special Edition in recognition of the more than 10 years of partnership between Apple and (RED). This is the Global Fund working to eliminate AIDS. Apple has contributed more than $130 million to date. Since it's founding in 2006 (RED) has generated more than $465 million for the Global Fund. The Special Edition iPhone 7 and 7+ with 128gb or 256gb start at $749. The models will be available worldwide on March 24th.
Apple also introduced a new iPad with 9.7-inch retinal display. The 32gb memory with WiFi will start at $329 while the WiFi and cellular model starts at $459. This is cheaper than prior versions of the iPad, reflecting the increased competition.
Bernstein raised their target price for Apple shares to $160 from $140 saying the iPhone 8 upgrade cycle will be very strong. The analyst also noted that any tax change or change to the repatriation rules would provide a significant opportunity for buybacks and dividends along with stronger earnings.
Well after the close Sears (SHLD) filed its annual report with the SEC and warned that it may cease to be a "going concern" at some point in 2017. This is a red flag warning and they waited until after the afterhours session was over before they filed the report. Last week the lenders for Sears hired a bankruptcy attorney so they knew there was trouble ahead.
The streak is dead. All those various streaks on the indexes where they went X days without an intraday move of 1% or a closing move of 1% or more are dead. All those watching and waiting for "the correction" have finally got something to point to and say we knew it was coming. However, it may not be over. Very rarely does the market just drop unexpectedly -1.5% or more on one day and suddenly reverse to the upside.
Critical support has been broken on the major indexes and now it is time to see if the sellers have any conviction. It is one thing to drop sharply on several headlines but an entirely different event if that decline continues for several more days.
At this point, I would not be surprised if we continue lower because the healthcare train wreck could be the gift that keeps on giving. Remember, the bigger picture. If the healthcare bill is delayed, it pushes everything else including the tax cut proposals, well into the future. That tax cut proposal is the pot of gold at the end of the rainbow. If the rainbow begins to fade, the tax cut benefits already priced into the market will begin to fade with it. I have written several times that Citigroup believes the market will decline 10% if it appears the tax cuts are going to be postponed until 2018. That is not the case, yet, but every day they do move farther into the future.
The S&P broke through support at 2,360 and closed on light uptrend support at 2,345. Any further decline would target the 2,250 level according to multiple analysts. That would be about a 6% correction. The 2275-2300 level could produce a pause but that support is light.
The four largest decliners on the Dow accounted for more than 120 Dow points. Goldman was the biggest loser at -$9 which erased 62 points from the Dow. The financial sector was crushed. The SPDR Bank ETF (KBE) lost nearly 5% while the Financial Select SPDR (XLF) declined -2.88%. The XLF has other components like insurance companies.
The Dow has been the weakest large cap index and it blew through support at 20,800 to close at 20,668. There is some converging light uptrend support at 20,500 and that could easily be hit on Wednesday. The Dow is unsupported at today's close so the most likely path is lower.
The Nasdaq lost -108 points or -1.8% to close 5 points below critical support at 5,800. That is close enough to claim it honored that support, if it rebounds on Wednesday. The Nasdaq had its props knocked out with the biotech sector falling -4%. The Biotech Index lost a whopping -149 points. This is a result of the failing healthcare bill. Analysts are worried there will be drug price restrictions to help get the bill passed. Uncertainty is a killer in the markets.
It was a big cap disaster with all the major stocks except for Facebook and Apple, clustered at the top of the biggest loser's list. The majority of the others are biotechs.
The Nasdaq needs to hold that closing level to have a chance at a rebound. Unfortunately, the Nasdaq futures are down -15 as I type this commentary. The next chance of decent support is in the 5525-5575 range.
Despite the big cap slaughter, the Nasdaq 100 only broke initial support at 5,340. The 5,300 level still has a chance to contain the decline.
The Russell 2000 stopped short of critical support at 1,340 so there is still hope for a recovery. However, with the S&P-600 closing at a 4-month low, the Russell may be only a day behind in the plunge.
Tomorrow is not looking good. The S&P futures are down -7 as I type this and continuing to decline. Sometimes these events become self fulfilling as selling begets selling and investors panic as they race for the exits. Everyone has been so complacent for the last four months that a sudden reversal of fortune has caught most investors by surprise.
Investors forgot that a 1% down day is not unusual. Having 110 consecutive days without a 1% down day is unusual.
I would still buy a rebound. I would not buy the dip. When it appears a bottom has formed, I would take a chance with some prior winners. They will be the first stocks to rebound because traders have a short memory. What worked before should work again or at least that is the idea.
Remember, the three-week period after March option expiration is typically choppy with bouts of selling as investors restructure their portfolios for the Q1 earnings cycle and extract cash for the taxman.
Enter passively, exit aggressively!
Send Jim an email
If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.