The Russell 2000 traded negative most of the day but squeezed out a gain at the close.

Market Statistics

The end of quarter retirement cash flows should be nearly over. The rotation into small caps may be nearly over as well. The Russell traded positive at the open and again at the close but was in negative territory most of the day. The large cap indexes were positive all day with a steady upward trend. That suggests at least some investors may be starting to take some small cap profits as they rotate back into large caps for the Q3 earnings cycle.

The Russell 2000 has gained 162 points since the August 21st lows. That is roughly 12.2% and it is time for a rest.

There were no market moving economics today. The CoreLogic Home Price index for August rose from 6.7% to 6.9%. Single-family homes, excluding distressed properties, rose +0.8% in price and were up 6.1% over the same period in 2016. The index has finally surpassed its prior peak from April 2006 after 58 months of consecutive growth. Demand is continuing to rise and there are only 4.2 months of inventory available for sale.

The New York ISM report for September declined from 56.6 to 49.7. That was the second consecutive decline from the peak at 62.8 in July. This was the second weakest month in 2017. The six-month outlook component remains positive at 58.4 but declined from 60.5. However, the employment component declined from 56.4 into contraction territory at 48.3. The quantity of purchase component did the same thing with a drop from 51.6 to 48.1.

Vehicle Sales for September hit 18.6 million, annualized. That was up from 16.1 million in August and way over consensus estimates for 17.1 million. The surge came from demand for replacement vehicles after Harvey and Irma. Current insurance estimates suggest there were 800,000 cars flooded by Harvey. Irma and Maria were not as deadly for cars but there will continue to be additional buying for the next 2-3 months as the insurance claims are paid. Harvey will go down in history as the most expensive storm ever in terms of vehicle damage.

Auto sales rose from 6.0 million to 6.8 million. Truck sales exploded from 10.1 million to 11.8 million on an annualized basis. Domestic vehicles rose from 12.6 to 14.6 million. At 65% of the total sales, that was a historic high. New vehicle prices rose to an average of $31,058 and also a record high. Auto manufacturers had a surplus of 500,000 to 600,000 vehicles in inventory as a result of slowing sales throughout the year. The storms rescued them from massive markdowns but the average sales incentive was still a record $4,050 per vehicle.

Wednesday's ADP Employment and ISM Nonmanufacturing are the main reports. The ADP estimates have been reduced from 172,000 to 140,000 over just the last three days. It appears everyone is afraid the hurricanes have really impacted the job market. The Nonfarm estimates have been reduced from 140,000 to 100,000 over the same period with Moody's projecting only 75,000. The actual numbers will not matter because everyone understands the storm impact is temporary.

The hurdle for Wednesday is the Janet Yellen speech. In the speech last Wednesday, she was alternating between dovish, hawkish and confused. She will probably try to clarify her presentation if she gets the chance.

After the bell, the API inventory report showed a decline of 4.079 million barrels of oil compared to estimates for a 750,000 barrel decline. Pushing prices lower in the evening session was a build of 4.19 million barrels of gasoline, four times larger than expectations. Prices declined to $50 on the news. Distillate inventories declined 584,000 barrels. Oil inventories at Cushing rose 2.084 million barrels. We also learned that OPEC increased production by 120,000 bpd in September according to a Bloomberg survey.

In stock news, Lennar (LEN) reported earnings of $1.06 that rose 5.6% and beat estimates for $1.01. Revenue of $3.26 billion rose 15.1% and beat estimates for $3.24 billion. They sold 7,598 homes in the quarter, up from 6,779 in the same period in 2016. The average selling price rose 3.6% to $375,000. They raised their guidance for the full year from $370,000-$375,000 to $380,000-$385,000. They warned that deliveries of about 950 homes would be pushed into the next quarter because of the hurricanes. Orders rose 8.4% to 7,610. The builder warned they saw higher costs ahead as hurricane rebuilding efforts consumed large amounts of lumber, sheetrock, carpet and paint.

Paychex (PAYX) reported earnings of 62 cents that rose 11% and beat estimates for 60 cents. Revenue of $816.8 million rose 4% and barely beat estimates for $816.0 million. They ended the quarter with $368.2 million in cash and no long-term debt. During the quarter, they paid $179.1 million in dividends and repurchased $94 million in shares. The company guided for 6% revenue growth, up from 5% and revenues of $3.34 billion, slightly ahead of analyst estimates for $3.31 billion. Shares rose 3.6% on the news. The PAYX chart scares me. There is constant volatility and I would not be a buyer.

Stifel upgraded the restaurant sector with Dominos (DPZ), Darden (DRI), Wendy's (WEN) and Yum Brands (YUM) getting a buy rating. The analyst said these chains have healthy sales momentum, significant expansion plans and a desire to return cash to shareholders. He was negative on Brinker (EAT) and Buffalo Wild Wings (BWLD) because of declining traffic.

Deutsche Bank downgraded Urban Outfitters (URBN) to sell from hold. The analyst said peers L Brands (LB), Buckle (BKE) and Zumiez (ZUMZ) will report same store sales soon and we expect the multiple for these retailers to contract. URBN shares have rebounded nearly 45% from their August 15th low of $16.82 and they are expected to retrace some of those gains. DB put a $19 price target on the stock.

Wal-Mart (WMT) bought delivery startup Parcel. The company specializes in last mile delivery. Parcel is a 24/7 operation that delivers packages the same-day, overnight and in scheduled 2 hour windows. The acquisition price was not disclosed. Wal-Mart said they plan to leverage Parcel to deliver general merchandize as well as fresh and frozen groceries the same day they are ordered. Parcel will deliver for Wal-Mart and, the online retailer Wal-Mart bought for $3 billion last year. These acquisitions are weapons to use against Amazon and Whole Foods.

Tesla (TSLA) reported production for Q3 and it was not pretty. They had previously expected to build 1,500 of the Model 3 and only produced 260. The company said there were no issues with the car, just growing pains as unexpected production bottlenecks appeared. They believe those have been resolved and Q4 production will be higher. They are still forecasting 5,000 a month in December and 10,000 a week by the end of 2018. Overall they delivered 26,150 vehicles. Elon Musk had previously warned the company was entering into "production hell" with the start of the Model 3 and apparently, he was correct.

Goldman Sachs rates Tesla a sell with a $210 price target. Morgan Stanley is neutral with a $317 target. Guggenheim said they see supply chasing demand for the next 2-3 years and have a $430 target. After the close today, Nomura initiated coverage with a buy rating and street high price target of $500. They see revenue increasing from $8 billion in 2016 to $58 billion in 2021. The average target for the street is $304.

Susquehanna downgraded MGM to neutral from positive after the disaster in Las Vegas. MGM owns Mandalay Bay. The analyst said business will rebound over the long term but in the short term, there is the possibility of earnings revisions due to lost revenue. I saw a long line of people checking in on Tuesday afternoon. I seriously doubt what happened will deter many people from completing their trips. Consumers will view the disaster as a lightning strike, a onetime event that is not likely to be repeated. They will probably refrain from large outdoor crowds but Vegas tourists are likely to be immune to almost anything. More than likely, they may turn into gawkers and go out of their way to view the scene.

Deutsche Bank cut F5 Networks (FFIV) to a sell with a $90 price target, warning that increased competition could detract from earnings growth. The analyst warned the stock could decline another 25% with revenue growth falling from 4% to 1%. Shares fell 5% on the news.

After the bell, Office Depot (ODP) said it was going to buy CompuCom for $1 billion and lowered its guidance. CompuCom is an IT company and ODP views it as the first step away from being simply an office supply company into an IT services company as well. Office Depot will issue new shares for the acquisition and pay down CompuCom debt with cash. ODP said operating income for the full year is now expected to be $400-$425 million, down from the prior guidance of $500 million. They blamed the hurricanes and lower back to school traffic. Shares fell 9% in afterhours. They cannot drop much lower.

Ford (F) announced plans to slash $14 billion in costs over the next five years and move away from autos and internal combustion engines to develop more trucks and electric and hybrid cars. The savings are not expected to show up in earnings until 2019 and 2020. They will maintain their production of trucks and SUVs in North America. The company is open to more partnerships to reduce cost and risk in the restructuring. The CEO said shifting to only all-electric vehicles would be like walking off a ledge where we destroy the earnings power of the company. They still plan on one-third of their vehicles to be internal combustion in 2030. He said electric vehicles could have an assembly area half the size, require half the capital investment and 30% fewer labor hours per car. Maybe CEO Farley should check on how that production is working out for Tesla.


All in? After the rally over the last week, have investors gone all in on the stock market for Q4? While there has been a lot of price chasing and capitulation buying, I suspect there are still a lot of investors holding off on buying a market top. Everyone would like to buy a dip but unfortunately, there have not been any recent dips. The ones we have had were minor and not enough to really draw in the retail investor.

Hedgeye had a new cartoon out yesterday titled, "Gandalf's Wise Words."

With the end of quarter retirement cash flows nearly over, I could easily see the Russell retracing some of its gains. With the first two weeks of October normally volatile, we could see some window undressing and one last surge of portfolio restructuring before the Q3 earnings cycle begins. While I am not betting on a dip, we should always be ready. I do expect a positive market through the earnings cycle.

The S&P closed at a new high with a minor 5-point gain. There were 259 advancers and 196 decliners on the S&P for Tuesday but A/D volume was 2:1 in favor of advancers. The pace of gains slowed slightly but that does not mean they are over.

The S&P is well above prior resistance and in blue-sky territory.

The Dow shook off the 8-days of lethargy while investors were rotating into small caps, and surged with large back-to-back gains. That powered the Dow over uptrend resistance and round number resistance at 22,500. The sudden surge in gains was powered by end of quarter cash flows and a move back into the big cap stocks. On Monday, only 5 Dow components posted losses. Today, only 6 posted losses. This shows very good market breadth.

There is no specific reason for the Dow to retrace at this point but the market never needs a specific reason to take profits.

The Nasdaq has struggled with the big cap tech stocks being weak but the index has now posted five consecutive days of gains. The last two have been decent but rather anemic compared to the 40-60 point days we would like to see. The big caps were mostly positive for a change with the individual losses minimal.

The Nasdaq is well below potential resistance around 6,650 and the relatively minor advance is far from being overbought. If investors begin to buy the big caps ahead of earnings, we could see the Nasdaq move over the 6,600 level.

The Russell 2000 has gained 162 points nearly nonstop and it is due for a rest. With the cash flows fading and the rotation having run its course, I would be very surprised if we did not see a decent dip in the index. The A/D line in the small caps was 3:2 positive today but A/D volume was almost dead even. When I was doing my scans for potential Premier Investor plays today, there were a lot of small cap stocks with almost no movement. They were either up 10 cents or down 10 cents but overall the momentum had evaporated.

We have not had a seasonal trend this year where the market did what was expected. With the first two weeks of October normally volatile, the contrarian view would suggest a directional market. I am not going to bet on either direction. We need to trade what the market gives us this week rather than what we expect.

Yellen's speech could be a pothole or it could be ignored, depending on what she says.

The Russell "should" fade but it would be a buying opportunity if it happens. Be prepared.

Enter passively, exit aggressively!

Jim Brown

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