The Dow posted major back-to-back declines for the first time in 2017.
The major indexes were all headed lower in early trading but multiple events combined to lift the indexes off their lows. The Nasdaq Composite hit round number support at 6,200 and rebounded. The Russell 2000 hit support at 1,350 and rebounded. The Dow and S&P were still declining with the S&P hitting its low of 2,420 at 9:55 and the Dow reaching its low of -109 at 21,641 at 11:05. When the Bannon news arrived at 11:30 a short squeeze hit that lifted the Dow 152 points to gain +43 over a matter of just a few minutes. The peak was hit at 12:40.
However, I think the rebound on the Russell set the stage for the headline spike on the other indexes. The 2,420 level on the S&P was also a factor. Without the Bannon news those levels may not have made a lot of difference at the rate the Dow was declining but they provided support to the Dow recovery and sent traders scurrying to cover short positions. Unfortunately, weekend event risk weighed on the indexes at the close to produce back-to-back losses.
Consumer sentiment for August came in hot at 97.6 and the highest reading since January. This was a 4.2-point jump from the 93.4 in July. The present conditions component fell from 113.4 to 111.0 and the lowest since November but the expectations component soared from 80.5 to 89.0 and the highest level since January. Those respondents expecting business conditions to improve rose from 28% to 34%. Those expecting the economy to continue prospering over the next 12 months rose from 48% to 55% and the highest level of 2017.
The calendar for next week is short but has plenty of important events. The New Home Sales and Existing Home Sales will generate attention with both expected to post minor gains.
The biggest event is the Janet Yellen speech on "Financial Stability" on Friday and that will be a showstopper because she is expected to make the case for tapering QE purchases starting at the September FOMC meeting. All eyes will be glued to the event.
Mario Draghi, head of the ECB, will be in attendance but he will not speak. The ECB is trying to come up with plan of its own to reduce QE purchases.
With US inflation falling to 1.4% in the latest report and the Euro at 2-year highs, the Fed is going to find it tough to hike rates again this year. They may still squeeze one into the calendar but the justifications will be weak. If they are actually data dependent, the data does not support a hike.
The yield on the ten-year traded down to 2.163% at the open and very close to the 2.13% low for the year. The yield rebounded on the Bannon news on hopes the trade policy would not be as restrictive as Bannon wanted.
The outlook for the U.S. economy is looking better. The Atlanta Fed real time GDPNow for Q3 is predicting growth of 3.8%. The outlook started at 4.0% at the beginning of August and the forecast has managed to hold that stronger forecast. There are still a couple months of economic reports to digest before we know the final result. The Q2 forecast started at 4.3% and ended at 2.8% growth so plenty of time for changes. The actual Q2 GDP was 2.57% growth so very close to the GDPNow forecast.
The earnings calendar for next week is relatively uneventful with only a few highlights. Salesforce.com on Tuesday, Hewlett Packard on Wednesday and Broadcom on Thursday will lead the headlines. Lowes, Autodesk, Gamestop and Ulta Beauty will also attract attention.
In this Q2 cycle, 474 S&P companies have reported earnings and 73.8% have beaten estimates, well over the long-term average of 64%. More than 68.8% of companies have beaten on revenue and higher than the average of 59%. The projected earnings growth is currently 12.1%. Estimates for Q3 are now 6.7% with a rebound to 12.2% in Q4. There are 17 S&P companies reporting this week. All the Dow components have already reported.
Foot Locker (FL) was the biggest loser on Friday morning after reporting earnings of 62 cents compared to analyst estimates for 90 cents. Revenue of $1.7 billion missed estimates for $1.81 billion. Gross margin was down 300 basis points. Same store sales fell -6.6% compared to estimates for a 1% increase. The CEO warned that same store sales could be down 3-4% for the rest of the year. Guidance for 2H suggests earnings of $3.50-$3.75 compared to estimates for $5.43. Shares fell -28% on the news. Shares are now down more than 50% since May.
Hibbett Sports (HIBB) hit a 14-year low after reporting a loss of 15 cents that actually beat estimates for a 20-cent loss. However, revenue declined from $206.9 million to $188 million and missed estimates for $190.3 million. Same store sales fell -11.7% and worse than estimates for a -10.0% drop. The carnage in the stock price came after they cut full year guidance from $2.35-$2.55 to $1.25-$1.35 and same store sales guidance from flat to down mid to high single digits.
Deere & Company (DE) reported earnings of $1.97 that rose 27% and beat estimates for $1.93. However, revenue of $7.81 billion missed estimates for $7.9 billion. Agriculture & turf sales rose 13% to $5.34 billion but missed estimates for $5.42 billion. The company said equipment sales were expected to rise 24% in the current quarter. For the full year, they are projecting an 11% rise in revenue and net income of $2.075 billion. That minor revenue miss caused a 5% decline in the stock but given the positive guidance this could be a buying opportunity.
Estee Lauder (EL) reported adjusted earnings of 51 cents that beat estimates for 43 cents. Revenue of $2.89 billion beat estimates for $2.85 billion. They guided for the current quarter for earnings of 94 to 97 cents with analysts expecting 91 cents. Revenue is expected to rise 9-10%. Shares spiked 8% on the news.
There were mixed reasons given for the spike in WTI Friday afternoon but the one most likely was the impending futures expiration on Tuesday. When the market began rallying on Bannon's exit there may have been some urgency to cover shorts. Bannon was nationalistic and against free trade. With him out of the White House, trade deals are expected to be broader and probably not as harsh as some of the prior rhetoric had suggested. With only one day left to trade, those hoping to ride the futures a little lower before expiration, suddenly decided it was time to exit.
Earlier in the week, the EIA reported an 8.9 million barrel decline in inventories after a 6.5 million barrel decline the week before. In the last 7 weeks inventories have declined -42.7 million barrels. That pushed inventories down -13% for the year. However, prices did not rise on Wed/Thr because everyone knows driving demand is going to plummet the week after Labor Day.
Drillers are also cutting back on active rigs. They dropped 5 oil rigs last week and added one gas rig. Over the last six weeks, they have dropped a net of 6 rigs or 1 per week. Over the prior 25 weeks, they added 293 rigs or an average of 11.7 per week. The weakness in WTI down to $42-$44 in June/July was a serious reality check for drillers. If the normal summer demand cycle and 1.8 mmbpd in cuts by OPEC/non-OPEC producers could not raise prices then the long-term outlook was in trouble.
Volatility is increasing. The VIX did not spike on Friday but market volatility still increased. Whenever you have the Dow fall more than 100 points, rebound 152 points and then give back most of those gains, the volatility has increased. If you look back over the last week, a pattern has repeated.
The market was down sharply on Thr/Fri the prior week and then rebounded on Monday when the weekend event risk evaporated. The short squeeze held for three days then the indexes collapsed again to a 5-week low on the S&P. The S&P declined 55 points from Wednesday's high to Friday's low or a 2.2% drop. If we use the 2,480.91 closing high from August 7th that is just a 2.4% decline to Friday's low. It is unusual for 2017 but far from unusual in terms of normal markets that suffer a 3-5% decline several times a year.
Volatility is typically a sign of market tops and bottoms. Since the normal Aug/Sep weakness begins in option expiration week in August, we should not be surprised with the decline. Unfortunately, we are so accustomed to markets only going up and dips always being bought, some investors are learning there is actual risk in the market.
We have reached a point where the market is moving as we expected. That is scary since it rarely moves as expected. This could be the first historical trend that actually works this year.
In past years when we reached this point, I posed the question "Why buy?" Earnings are basically over. There is a strong chance for extreme volatility in September when lawmakers go back to work and begin attacking each other on the budget bill and debt ceiling hike. The Fed is going to begin reducing QE purchases in September and Q3 earnings are projected to be half of Q2. Portfolio managers typically take some chips off the table in Q3 and raise cash for the expected Q4 rebound. More often than not, we see a second half low in Sep/Oct.
I am not recommending investors sell stocks, only that they understand the risks of opening new long-term positions.
The recent increase in volatility suggests investors are considering all those possibilities and the decline into September has begun. There is no guarantee but the shrinking market breadth is the key indicator.
The S&P tested initial support at 2,420 on Friday and I expect it to retest the 2400-2410 level soon. This could be the first dip buy point for those traders still looking for a quick rebound. I plotted the percentage declines for each of the major support points.
The wild card for predicting a decline is the legislative battle in late September. The last time the government was shutdown was 2011 and we all remember the -246 point S&P decline over 11 trading days. While I do not expect a repeat, Goldman Sachs says there is a 50% chance of a shutdown this year. Just having those odds continually quoted in the market headlines, makes it more likely investors will take chips off the table ahead of the actual battle.
The Dow has multiple levels of support but it is hard to judge the potential effectiveness because of the 30 stock index. Any one or two stocks can cause a major move on any given day and punch through support levels. The key ones to watch are 21,500, 20,900 and 20,400.
Even though Friday's final loss was only 76 points, there were very few gainers. Recently, the winners and losers have been close to evenly split but as you can see in the table below, the breadth is fading.
The Nasdaq was relatively tame on Friday with a 60 point range and only a 5 point decline at the close. The big cap techs were mixed with TSLA posting the largest decline at -$4. Even the high dollar stocks like AMZN, PCLN and GOOGL were just barely negative. As long as the big caps can hold their current levels, the broader index is not likely to move significantly lower. Unfortunately, FB, NFLX, NVDA, GOOGL, AMZN, PCLN and TSLA all have negative trends. I am just going to post the Amazon chart but the rest are similar. They are right on the edge of a breakdown that could take the Nasdaq a lot lower.
After hours totals:
At this point, the odds are pretty good the Nasdaq will test 6,100 in the near future. That would be a 5% decline and where it goes after that test is the big question. If the legislative battle heats up early, I would not be surprised to see a retest of 5,800 and basically a 10% decline.
The Russell 2000 is the weakest index, now down -6.4% from its high. The initial support at 1,350 was tested on Friday and the critical level is 1,340. If we lose that lower support there is a tremendous amount of empty space to fill before the low at 1,156 from November. I am not saying we are going to the November lows but if 1,340 breaks, the decline could accelerate.
It appears that every weekend has turned into a high-risk event. Traders are willing to be long during the week but afraid to be long over the weekend. On Friday North Korea was warning the joint exercises between the US and South Korea would cause a "major catastrophe" if they were held on schedule. The US and South Korea hold annual joint exercises and Kim Jong Un routinely warns they are a rehearsal for an invasion of North Korea. They begin on Monday.
The rapidly changing political landscape is also a risk. With two of President Trumps executive committees being disbanded last week, a panel advising the president on cultural issues resigning in mass on Friday and chief advisor Steve Bannon being asked to leave, there is considerable political risk. All week traders worried over who would be the next cabinet member to exit with worries multiple members could resign over the Charlottesville comments. Presidents in stress tend to do bigger things to distract from the little things. Ramping up geopolitical issues is a favorite target to distract from issues at home.
With people leaving at a rapid pace and verbal warfare against people in his own party, the outlook for Trump's agenda is looking grim, including tax reform and infrastructure spending. The market has sustained a 9-month rally on hopes for good things from a business friendly president. Once the market begins to believe those reforms are not coming, the direction could change.
The Bannon exit was seen by the market as a positive event because it would suggest less restrictive trade policies. However, Bannon has gone right back to Breitbart News where he is likely to become a very high profile attacker of the more moderate people still in the administration. He has a very large pulpit from which to launch attacks if that is his desire.
Over the weekend he said, "The Trump presidency we campaigned and fought for and won is over. We still have a huge movement, and we will make something of this Trump presidency. But that presidency is over. It will be something else. And there will be all kinds of fights, and there will be good days and bad days, but that presidency is over. I just think his ability to get anything done, particularly the bigger things, like the wall, the bigger, broader things that we fought for, it's just going to be that much harder." That statement is obviously a clue about his plans. On the plus side, Bannon said Trump's current advisors will try to "moderate him and make him more conventional." That would actually be good for the market if there was less drama and volatility in the White House.
The bottom line is that the market has event risk and not just weekend event risk. Given the place on the calendar, the Fed and the legislative events in September, I would be very surprised if we did not see some lower lows in the weeks ahead.
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This survey ended on Wednesday just before the Thursday decline. There were no major changes. Everyone is pretty confident in their positions. 66% still believe the market is not going higher.
Goldman Sachs said there was a 50% chance of a government shutdown "due to President Trump's declining poll ratings." The president's approval ratings fell another point to 37% in the last weekly poll. That is the lowest of any first-term president at this point in his term. According to Goldman, "Low approval ratings raise legislative risk." The debt ceiling must be raised by September 29th and failure to do this would force a shutdown. "We believe it would be brief." Goldman said the odds of a shutdown are "fairly high" because Democratic support for the spending bill will be required, which will force Republicans in Congress to make some difficult concessions.
Goldman said, "We continue to believe a tax cut is slightly more likely than not, but our conviction is low, as there has been little progress to date. If tangible progress has not been made by October, after these fiscal deadlines have passed, tax legislation will start to look less likely, in our view."
Art Cashin warned on Friday the Dow would drop up to 500 points or more if multiple Trump advisors were to resign. That would not happen in one day but over time. Cashin said traders were worried that a Gary Cohn departure could result in the exit of Wilbur Ross and others. There were a lot of rumors about a Cohn departure earlier in the week but the White House eventually squashed them saying there was no truth to the speculation.
After the close on Friday Carl Icahn resigned from his role as special advisor to the president on regulation. He said he discussed it with the president and the decision was made with Trump's blessing. Icahn said he wanted to avoid "partisan bickering" and scrutiny regarding his role. Some Democrats had asked regulators to look into Icahn, a major investor in energy and equities, to see if he had engaged in any improper behavior. In his resignation letter Icahn stressed he had never had any access to non-public information or profited from his advisory position.
A new study found that raising a child from birth through age 17 costs about $233,610 or roughly $13,000 a year on average. Higher income families spend significantly more, around $372,210 and lower income families averaged $174,690. A household earning $200,000 a year could expect to spend $52,000 in just the first year of a child's life according to NerdWallet. If you elect to cover college you can spend $20,090 per year for average instate tuition and $34,220 for out of state or private institutions. Yes, kids are expensive but worth it.
As I typed those numbers, I wondered how my generation survived when our parents had a single wage earner, mother at home and average income of less than $5,000 a year. (1950s) Of course the average house cost $22,000, a Ford $2,000, milk 92 cents, bread 18 cents, gasoline 23 cents and sirloin steak 69 cents lb. Fifties Prices
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