The sudden 143-point Nasdaq decline on Thursday may have damaged market sentiment.

Weekly Statistics

Friday Statistics

With multiple highly regarded market analysts warning of an impending sell off and the sudden 143-point Nasdaq decline on Thursday, we could be nearing a point where investor sentiment is going to sour. The Nasdaq crash like we saw on Thursday, tends to knock a bunch of people out of the market as their stop losses are hit. Investors understand when a stock declines for a reason like an earnings miss but when the top 20 stocks decline 4% to 5% in just a few minutes without any news, that is a shock to sentiment.

The Nasdaq dipped to support again on Friday but rebounded slightly to end with only a 7 point loss despite the Amazon earnings miss. That suggests any sentiment damage was light and there are still investors buying the dip. However, do you remember August of 2015?

Starting on August 18th, 2015, the S&P declined from 2,101 to 1,867 in ONLY five trading days. That was a drop of -235 points. The Nasdaq dropped -800 points in those same 5 days. The VIX shot up from 14 to 53 in 3 days. So what caused this? The decline began on Tuesday of option expiration week and was fed by a market drop in China to six-month lows, Grecian Prime Minister Alex Tsipras said he would resign after losing parliamentary majority and some bland FOMC minutes that suggested the economy was doing fine and the Fed could begin hiking rates over the coming quarters. Who knew a relatively benign series of events could knock 11% off the S&P in five days? (FYI, if you are researching past market events, did you know you can go back to ANY daily market commentary on all the way back to 1998? That really comes in handy when trying to learn why the market moved on any particular day.)

Prior to the decline, the market decline the S&P had been moving sideways in a 75-point range for more than five months. Suddenly one morning somebody kicked off a sell program that triggered a cascade event where sell stops were hit causing volume to increase and volatility to explode. Liquidity evaporated because the dip buyers were overrun on the first drop below 2,050. There is not an unlimited supply. Once they are blown out, the market can free fall until sellers run out of stock.

S&P August 2015

The Volatility index had been idling along for an extended period of "abnormally low volatility" just like we are seeing today. I wrote in the Option Writer newsletter on Wednesday, "When volatility returns it seldom arrives slowly. It tends to arrive suddenly and violently." The 2015 market crash was a prime example. The headlines were not expected and individually they were not that bad. The market does not need a reason to decline. It declines when investors large and small suddenly decide in the same week that maybe it is time to take some chips off the table.

I recommend all readers reevaluate the amount of capital they have at risk as we head into the normally volatile Aug/Sep period. Unexpected events do happen with some regularity.

VIX August 2015

The lead economic report on Friday was the GDP for Q2. The headline number rose from 1.24% growth in Q1 to 2.57% in Q2. Consumption contributed 1.93%, fixed investment 0.36%, exports 0.18% and government 0.12%. Inventories removed 0.2%.

Real disposable income rose 3.2%, up from 2.8% in Q1. The personal savings rate declined from 3.9% to 3.8%. The PCE inflation indicator showed a 0.3% rate of inflation, down from 2.2% in Q1. The core rate, excluding food and energy, declined from 1.8% in Q1 to 0.9%.

Despite the fluctuations from quarter to quarter, the economy continues to muddle through the post crisis expansion period at almost exactly a 2% growth rate. The economic expansion is now 8 years old and the third longest in history. In reality, the economy is remarkably stable given the almost full employment and the lack of any material inflation.

The final reading on July consumer sentiment improved slightly to 93.4 from the initial 93.1 reading. This was the lowest reading since October and the second month of 2 point declines. The present conditions component improved from 112.5 to 113.4 and the expectations component declined from 83.9 to 80.5.

We have a busy calendar for next week with home sales, ISM and employment data. The jobs will be the most important with the ADP Employment number expected to rise from 158,000 to 186,000 jobs for July. The ADP numbers have missed expectations to the downside the last several months. The Nonfarm Payroll numbers on Friday are expected to decline from 222,000 to 182,000. The nonfarm numbers have greatly exceeded expectations the last several months. Regardless of the numbers, the Fed is likely on hold until December, according to most analysts and quite a few do not expect any further rate changes until 2018.

The rest of the economic reports have been relatively stable with the occasional dip or gain but remaining near the recent trend.

Stock news was very light on Friday with volume light at 5.99 billion shares. It was a summer Friday and volume was actually a little higher than normal with only three weekends left before kids begin returning to school. If traders are going to squeeze in another vacation, time is running out.

Advancers of 3,504 narrowly beat decliners of an even 3,500. I do not recall seeing them that close in several years. Trading interest was definitely lacking.

Exxon Mobil (XOM) hit a 52-week low intraday after missing estimates. The company reported earnings of 78 cents ($4.3 billion) compared to estimates for 83 cents. Revenue of $62.88 billion did beat estimates for $61.16 billion. Production averaged 3.922 million Boepd and flat with the year ago quarter. Liquids production fell 3% to 2.269 million bpd due to field depletion. Natural gas production rose 2% to 9.92 Bcf per day thanks to gains in Australia. The refining division reported profits of $1.4 billion, up $560 million from Q2-2016. Exxon refined an average of 4.4 million bpd, a 5% increase. Capex declined -24% to $3.9 billion.

The company said they made the final investment decision for the Liza field, offshore Guyana. They are now projecting gross recoverable resources for the Stabroek block at 2.25 billion to 2.75 billion oil-equivalent barrels. That block includes the Liza field and discoveries at Payara and Snoek. They announced results and progress on multiple other discoveries. The company has a lot of future production coming online in the next 3-5 years.

On the flip side, Chevron (CVX) reported earnings of 91 cents compared to estimates for 89 cents. Revenue of $34.48 billion greatly exceeded estimated for $31.18 billion. Overall production rose an impressive 10% to 2.78 million Boepd. Production was boosted by multiple long-term projects coming online. Those include the Gorgon LNG facility, which is now 100% operational and the Wheatstone LNG facility where Train 1 is complete. They also started production at the Angola LNG project, Jack/St Malo in the Gulf, and the Alder project. They did not complete any asset sales in Q2 but they expect to complete another $5 billion by the end of 2017. They are currently producing 175,000 bpd in the Permian with production rising. Overall operating expenses were down 10% and capex spending declined 25% because most of the major projects are now complete. Shares rose $2 on the news and added 14 Dow points.

Dow component Merck (MRK) reported earnings of $1.01 compared to estimates for 87 cents. Revenue of $9.93 billion beat estimates for $9.79 billion. They guided for the full year for earnings of $3.76-$3.88 with revenue of $39.4-$40.4 billion. Revenue for the drug Keytruda nearly tripled to $881 million but their top selling drugs, Januvia and Janumet saw sales decline -8% to $1.51 billion. That missed estimates for $1.62 billion. Shares rose fractionally on the news.

Drug maker AbbVie (ABBV) reported earnings of $1.42 that beat estimates for $1.40. Revenue of $6.94 billion just barely edged by estimates for $6.93 billion. Sales of Humira rose 13.7% to $4.72 billion. Analysts were expecting $4.64 billion. U.S. sales rose 18%. The drug has a list price of $4,441 for a two-pen pack and is used to treat autoimmune disorders. Sales of their Hep-C treatment, Viekira Pak, were $225 million and missed estimates for $2.57 million.

AbbVie has the best drug pipeline in the market with multiple drugs nearing adoption that could generate sales over $1 billion a year each. However, shares declined slightly after earnings.

American Air Lines (AAL) reported earnings of $1.92 that rose 8% and beat estimates for $1.97. Revenue of $11.105 billion rose 7.2% but barely beat estimates or $11.087 billion. They plan on spending $4.1 billion on new aircraft this year as they renew the fleet. They spent $1.1 billion in Q2 for 16 mainline aircraft and 4 regional planes. These are replacing existing planes rather than simply making additions. They repurchased 10 million shares for $450 million and they have $1 billion left on their existing buyback authorization. Shares posted a fractional gain.

Rockwell Collins (COL) reported earnings of $1.64 compared to estimates for $1.58. Revenue of $2.09 billion rose 57% and beat estimates for $2.03 billion. They guided for the full year to earnings of $5.95-$6.15 with revenue of $6.8 billion. They ended the quarter with $578 million in cash. Shares spiked $4.71 on the news. All of the defense contractors have been reporting strong earnings and guidance.

Lithia Motors (LAD) reported earnings of $2.28 that rose 16% and beat estimates for $2.22. Revenue was $2.47 billion. They guided for the full year for earnings of $8.35-$8.50 with revenue from $9.6 to $9.9 billion. Same store sales rose 3%, used vehicle sales rose 4%, service, body and parts sales rose 7%. They announced a dividend of 27 cents payable August 25th to holders on August 11th. Shares rose $7 on the news.

As of Friday, 289 S&P companies have reported earnings and 73% beat expectations. This is above the long-term average of 64% and the short-term average of 71%. Of those 289 companies, 70.9% beat on revenue, also above the 59% and 56% averages. The current forecast for final Q2 earnings is 10.8% growth. There have been 83 instances of negative guidance and 45 companies issued positive guidance. The current 12 month forward PE is 17.9 for the S&P. Next week only one Dow component reports earnings, Apple, with 134 S&P companies reporting. After this week, 423 S&P companies will have reported and the majority of the Q2 earnings cycle will be over.

In addition to Apple earnings on Tuesday evening, Tesla reports on Wednesday, Activision Blizzard and YUM Brands report on Thursday.

Tobacco companies were hammered on Friday after the FDA said it was proposing a cut in nicotine to "non addictive" levels. The FDA chief, Scott Gottlieb, directed the staff to develop new regulations on nicotine. Most non-smokers are always amazed that cigarettes are even legal. Cigarette smoking is responsible for 480,000 deaths annually. If any other product caused even 100,000 deaths, it would have been banned long ago. The FDA said studies have found that reducing nicotine levels by 90%, leads smokers to be "less dependent."

There are concerns that a reduction in nicotine could lead to more smoking and even more harmful effects from the bad chemicals in cigarettes. However, studies have shown that reducing by 90% leads to less smoking because the dependency fades. With the availability of e-cigarettes there is no need to continue inhaling harmful smoke and the FDA is going to force that evolution. The FDA is also going to consider new regulations on cigars. Altria (MO) fell 15% intraday but rebounded to only a 7% loss. You can bet this decline is not over.

Snap Inc (SNAP) continues to decline but we could be nearing a turning point. With a 37% short interest of 69 million shares out of a float of 188 million, investors are betting the lockup expiration is going to be a disaster. More than 85% of the authorized shares will see their lockup expire in August. On Monday, 400 million shares are free to trade. On August 14th another 782 million shares are released. On August 30th another 20 million shares expire. Reportedly, officers and directors hold 60% of the shares to be released so we do not know what they are planning to do. Shares hit $29.44 on the second day of trading and have declined to $13.81 at Friday's close.

Investors have been betting that the lockup expiration will be a disaster given the decline in the stock price. People have seen the value of their holdings decline sharply as Facebook and others have cloned most of SnapChat's features and user growth has slowed dramatically. They may be tempted to jump ship and take whatever they can get today rather than wait for shares to rebound. Many expirations in the past have had the opposite results where very few holders sold and the stock rebounded when shorts were forced to cover. At the same time, there have been disasters so we will not know which occurs until it actually happens.

The Dow Transports crashed last week with a 244-point decline. In theory, the falling transports will be a drag on the Dow industrials but it did not happen with the Dow setting new highs nearly every day. The rising oil prices may be a drag on the transports but I suspect there are other forces in play. Railroads guided for a weak Q3 and shares declined. It was not that there was a shortage of freight but Q3 2016 had a strong uptick in freight so the comps for this quarter will be high. Airlines are packing people in as tight as possible so they are not reporting any serious traffic problems. Trucking companies are running ads for drivers on nearly every Sirius radio station with $5,000 sign on bonuses and guaranteed earnings and future bonuses. They are not hurting for business. This may just be profit taking from the big rebound to new highs but any further declines could be Dow negative.

Crude prices rallied strongly after Saudi Arabia said they would export one million barrels less per day starting in August and U.S. inventories declined sharply. The U.S. rig counts are starting to plateau according to Halliburton and some companies have talked about slowing their production efforts to let prices stabilize. All of those things are positive but one of them is fake news.

Saudi Arabia burns up to one million barrels of oil per day more than normal in August because they use oil to generate electricity for cooling and August temperatures are unbearable in Saudi Arabia. They have played this game many times in the past with promised cutbacks because they know the general public does not know about the extra demand. They cannot export that oil because they need it. Secondly, they said they would export 1.0 mmbpd less not "produce" 1.0 mmbpd less. That is the key fact. If they continue to export less after the August heat passes, it just means they will store the oil for future sale when nobody is watching.

Personally, I am glad Saudi Arabia captured trader's attention with the export ploy because that lifted crude prices, which supports the equity market. Unfortunately, there will come a day later this year when the export numbers rebound. Since the U.S. driving season ends with the Labor Day weekend, that export bump will be in a low demand cycle. Prices will be pressured again.


The market may have suffered some significant damage to sentiment on Thursday. The S&P suffered an outside reversal day meaning there was a higher high and lower low followed by a lower close on the following day. This is also called a bearish engulfing pattern in candlestick charting. The key here is the word bearish. While there is never a guarantee of future direction, the pattern typically indicates a change in trend. The chart may not look bearish and it may not work out that way but chartists all over the country are looking at those candles this weekend and trying to decide if they should buy the dip or sell the next bounce.

The key point is there is nothing wrong with earnings, the economy or the Fed. There is no specific reason why the market should decline. We know it does not need a specific reason but it normally takes a reason to push investors into action. With earnings expected to be over 10%, congress moving towards tax reform and the Fed on hold for months to come, the decision should be to buy the dip. Washington gridlock is positive for markets because nothing negative can be passed. However, the sudden outbreak of market warnings could be changing the way investors are looking at the market. Add in the fact that August and September are the two weakest months of the year and they may decide to take some chips off the table.

With liquidity shrinking as more and more investors move to passive funds and ETFs, any sudden changes in direction could trigger a significant move. The August correction in 2015 would be a prime example.

Initial support is now 2,465 with 2,483 as solid resistance. If we were to break through that level, the large round number psychological resistance at 2,500 could be a real challenge in a typically weak August.

Nearly every day last week the Dow benefitted from strong earnings related gains in several stocks. Boeing gained 29 points for the week and added 198.5 Dow points. The Dow only gained 250 points for the week so Boeing accounted for 79% of that gain. The odds of that happening again next week are zero. Apple is the only Dow reporter this week and I would be shocked if they posted a significant gain.

Thanks to Boeing and several others, the Dow has broken out to a new high and well over prior resistance. The next hurdle will be the round number resistance at 22,000. Coming in the month of August that could be a significant hurdle. Without a handful of Dow stocks posting large gains, I doubt the index is going to easily exceed that level.

Starting next week, the Dow should begin experiencing post earnings depression. That means traders will begin taking profits in those big earnings gainers and moving on to something else.

On Thursday, the Nasdaq hit 6,461 intraday for a new high then plunged -143 points to 6,318 intraday. The entire move took only about 90 minutes and traders bought the dip. However, the velocity of the rebound was lackluster and recovered only 52 of those points. That was followed by another dip at Friday's open, thanks to Amazon's earnings miss, and the index could not return to positive territory.

Friday's rebound was powered by the big caps with Google recovering some if its losses for the week. Apple remains unstable ahead of its earnings with every forecast imaginable making the rounds. Some have Apple surprising to the upside on the strength of everything but the iPhone and some have it disappointing because people held off on purchases in anticipation of the iPhone Pro/8. Many analysts believe Apple will have to guide lower because of the slippage in production of the new phone. Most analysts are not expecting deliveries until November. The good news is that any slippage will be made up in a much larger Q1. Translation, buy any material post earnings dip.

Over the last three months, we have had three similar declines in the Nasdaq. Only one of them rebounded immediately. The other two had some volatility issues for several days before a rebound occurred. That is entirely possible this time as well. However, since earnings are fading there is less incentive for traders to buy the dip in tech stocks. There has been such a flurry of dire warnings about an impending correction, they may want to cling to cash in hopes that comes true in Aug/Sep.

Support is well below at 6,100 but there could be some stutter steps at multiple levels on the way down. Once a real decline appears, traders will be eagerly awaiting a pause point to begin buying. That should limit any real decline.

The Russell had a decent rally going until Wednesday. The three-day decline knocked it back to support at 1,425 and that is a critical level. A breakdown there should target 1,400 and it would be damaging to market sentiment.

There was a $900 million buy program on the NYSE at the close on Friday. This overcame any decline caused by traders exiting positions ahead of the weekend. It would be nice if we knew who was buying but that information is not available. If it were a well-known hedge fund it would be bullish. If it were a sovereign wealth fund, it would not be particularly bullish because they do not normally time buys to capitalize on dips or opportunities. It is mechanical rather than opportunistic.

The main point to stress this weekend is that the majority of the big cap, high profile earnings are over. Post earnings depression should appear soon. Whether positive earnings expectations for Q3 can overcome that depression is of course unknown. Volume is going to be weak over the next month as vacations wind down and kids go back to school. Money will be leaving the market to pay tuition. I continue to recommend not being overly long in the weeks ahead. Respect the historical trend for weakness in Aug/Sep whether it comes true this year or not.

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Random Thoughts

With the markets closing at new highs on Wednesday, the day this survey closes, I would have expected a significant boost in bullish sentiment. Instead, there was a minor decline. Investors were moving to neutral and away from bearish but not quite bullish. Slightly more than 65% still believe the market is not going higher.

A mystery trader, not the recently unmasked "50 Cent" that works for Ruffer LLP, has acquired 262,000 VIX October $15 calls. To fund it he sold 262,000 VIX $12 puts expiring in October. He used those proceeds to buy a 1x2 call spread, which involves buying 262,000 $15 calls and selling 524,000 $25 calls. If the VIX spikes but does not exceed $25 in October, he could make up to $262 million. If the VIX exceeds $32.50, he would begin to lose money. The October expiration covers two Fed meetings, the Congressional budget battle and the debt ceiling battle at the end of September.

North Korea is nearing the point of military action. On Friday they launched an ICBM that flew 2,299 miles into space, roughly 10 times the height of the International Space Station and then returned to earth about 621 miles from NK to land in Japanese waters. Scientists have calculated the rocket could reach Denver, Chicago or Dallas and any city west of those locations. Kim Jong Un then announced they now have the capability to hit any U.S. city with a nuclear weapon. That remains to be seen since shooting an empty rocket straight up into space is a lot easier than accurately shooting a loaded one horizontally for 7,500 miles. However, U.S. Marine General Joseph Dunford, Chairman of the Joint Chiefs of Staff, contacted his South Korean military counterpart, General Lee Sun Jin, to discuss "military options."

In a new assessment, U.S. officials warned North Korea will be able to launch a nuclear capable ICBM as early as next year. President Trump said he was weighing "some pretty severe things" in response. North Korea already has two satellites that cross over the U.S. twice a day. I really hope they do not have EMP weapons Kim can use in the event North Korea is attacked.

A UK driver had a very bad day on Friday. The driver had just purchased a Ferrari 430 Scuderia, one of only 499 made and worth about $200,000. The car can go 0-60 in 3.3 seconds with a top speed of 198 mph. Within an hour of picking up the supercar, he totaled it when the car went airborne and crashed. The driver escaped with minor cuts and bruises but the car was completely destroyed. When complaining about your bad day, just remember, things could be worse.


Enter passively and exit aggressively!

Jim Brown

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"Much of the social history of the Western world, over the last three decades, has been a history of replacing what worked with what sounded good."

Thomas Sowell