The Dow plunged 350 points intraday, S&P -42, Nasdaq -137 and Russell 2000 -46.

Weekly Statistics

Friday Statistics

Fortunately, all the indexes rebounded to recover most of their losses. The combination of the Michael Flynn charge and headlines he would testify against the Trump administration along with the uncertain outlook for tax reform in the senate, pushed the indexes to lows that were downright scary for a few minutes.

The speed of the decline was the scary part despite a couple rebounds on the way down where program traders bought the initial dips. Each rebound was small and short-lived. Once the bottom was made at 11:30, there was 30 minutes of wild swings as the buyers and sellers battled it out. The index ETFs including the SPY, IWM, QQQ and DIA saw huge volume. The SPY normally trades about 50-60 million shares per day. Friday's volume was 164 million. Volume in the IWM averages about 23 million and 63 million shares traded. The QQQ averages 28 million and traded 59 million shares.

Art Cashin remarked as the bottom was being made that there was not a large surplus of sellers but all the bids were suddenly cancelled. Any computer trying to place a sell order was finding an air pocket that lasted for several minutes. Since 60% of our daily volume is computer trading, they are making the decisions based on headlines, direction and bid/ask spreads. When the machines hit a volatility event, they reset and wait for the volatility to pass. The bids are cancelled until the machines can detect a pattern that is tradable. These programs cost tens of millions of dollars but they need parameters that fit a scenario before they can trade. That scenario can take milliseconds to appear or even minutes depending on the volatility.

Add in the human traders and their stop losses and suddenly everyone is moving in the same direction. When something happens in the market that is unexpected like the initial -300 point drop in less than 8 minutes it cause a panic. The drop started at 11:06 and traders stared in disbelief. That turned into a panic to sell because they do not know what happened other than the bottom fell out.

Almost everyone believes we could have another flash crash even though we have a lot more circuit breakers today than we did when the first one happened. Anyone with reasonably tight stop losses was more than likely stopped out on Friday. With the tsunami of headlines on TV about Flynn, Trump and tax reform, I am pretty sure there were a lot of traders that simply sat out the rest of the day.




The headline causing the biggest problem on Friday suggested that Flynn was directed by the "highest levels" in the Trump headquarters to contact the Russians during the 2016 campaign. Brian Ross at ABC said in a special report that Michael Flynn is prepared to testify that "candidate," Donald Trump, "directed him to make contact with the Russians." That would be completely contrary to everything President Trump has said about the Russian collusion investigation.

Later, that statement was corrected to say Flynn was directed by a high-level person in the "post election transition team" to make contact with Russia "initially as a way to work together to fight ISIS in Syria." That was significantly different than the original news story.

The problem for Flynn is that he initially lied to the FBI about not having contact with Russia. Actually, having contact is not illegal but an unauthorized individual cannot negotiate anything. The 1799 law that forbids it has never been tested and is thought to be unconstitutional.

The key point is the lying, which to the FBI could suggest Flynn was trying to cover up something. There is also the question of whether President Trump was trying to obstruct justice at any point in the early stages of the investigation. When the story suggested Flynn had agreed to testify against the Trump administration, the ramifications could be huge and the headlines tanked the market.

Later in the day, the headlines were clarified again and it was Trump's son-in-law, Jared Kushner, in the president's transition team who directed Flynn to contact Russia about a UN resolution condemning Israel to determine their posture on the matter. This suggests Kushner is the one that may be in the FBI spotlight here.

On Saturday, the reporter, Brian Ross, was suspended for four weeks without pay for reporting false news. By saying it was "candidate" Trump instead of a person on the "post election transition team" the impact was dramatically different. Candidates are not authorized to negotiate with other countries. Transition teams always contact world leaders to get up to speed before inauguration. By saying it was candidate Trump there was an entirely different set of potential assumptions that crashed the market. Had he said a Trump transition team member, the market would not have crashed.

Early Saturday morning the tax reform bill in the Senate was passed with a 51-49 vote and will now move on to the conference committee to iron out the differences between the House and Senate versions. The president wants the bill passed before Christmas so it will be all hands on deck for the next week. Unfortunately, I think it is going to be VERY difficult if not impossible to get it done in that time frame. Because of the complexity of the differing views, we will be lucky to get it done in January.

The economic reports for Friday were mixed. The ISM Manufacturing Index for November declined from 58.7 to 58.2. That was down from the 60.8 in September and the highest level since February 2011 at 61.4. The index is still at multiyear highs. New orders remain strong at 64 along with employment at 59.7. Order backlogs were flat at 55.



Construction spending for October rose 1.4% and well over estimates for a 0.5% rise. Residential spending rose +0.4% and nonresidential rose 0.9%. Government/public spending rose 3.9%. This was the strongest report in five months.

Auto sales declined sharply from 18.1 million to 17.5 million on an annualized rate and below estimates for 17.8 million. This was significantly below the 18.6 million rate from September. The auto buying to replace hurricane-damaged vehicles has passed. Domestic sales declined from 14.2 million to 13.7 million while imported vehicle sales declined from 3.9 million to 3.8 million. Auto sales fell from 6.6 million to 6.4 million. Light truck sales declined from 11.5 to 11.1 million.

After the economic reports for the week, the Atlanta Fed real time GDPNow for Q4 is projecting a 3.5% growth rate. This was up from a 2.7% print on Nov 30th. The forecast of real consumer spending rose from 2.6% to 3.1% based on Friday's ISM. The forecast for fixed investment spending rose from 6.7% to 8.4% based on the surprise jump in the construction spending report. It is going to be exciting to see how the 2018 numbers play out if we actually get a tax cut.


The economic calendar for next week is highlighted by the payroll reports and the ISM Services report. However, the elephant in the room is the government-funding deadline for next Friday at midnight. Schumer and Pelosi have vowed to shut down the government if the republicans do not include a DACA provision to allow those individuals to remain in the US. There are several GOP lawmakers that would allow that to happen. There will be a fight simply because the democrats are going to try and impose their will on something because they are losing on the tax reform process. This could be a major market mover as the week progresses unless there is some sort of compromise.

There is going to be a push to try and get the tax reform out of the conference committee and passed before Christmas. There are only about 9 days for both items to be passed before both houses leave for the holidays. That means there will be a barrage of critical, potentially market moving headlines for the next two weeks.



The earnings calendar for next week has several retailers but the big report for the week will be Broadcom (AVGO).


Broadcom will likely provide an update on their move to the USA and the offer for Qualcomm (QCOM). Broadcom is planning on nominating a slate of directors for Qualcomm's board before the December 8th deadline. Reportedly, they will postpone increasing the offer price until just before the Qualcomm board meeting in March. By going hostile with the slate of board members, they are hoping to convince shareholders to lean on the board to accept Broadcom's next offer. That will force Qualcomm to try and convince shareholders why it should continue as an independent company in what is turning into a very competitive space. Broadcom offered $70 for Qualcomm and it was declined. A shareholder survey found that even a $10 hike in the price would convince most to sell.

Broadcom may also be waiting to see what happens with Qualcomm's acquisition attempt for NXP Semiconductors (NXPI). Regulators are holding up the deal but it should be cleared as early as the end of December. Qualcomm offered $110 and shares are trading at $115. Qualcomm will have to offer more than $115 to entice at least 80% of shareholders to tender their holdings so the deal can be completed. NXPI is a Dutch company and those are the rules in a hostile takeover.

If Broadcom acquires Qualcomm, they will immediately become the default provider for the basic set of components needed for the one billion smartphones sold each year. They would become the third largest chip company. Intel and Samsung are the top two.



There was some stock news on Friday but it was buried under the mountain of political headlines. Big Lots (BIG) reported earnings of 6 cents that beat estimates for 4 cents. Revenue of $1.11 billion missed estimates for $1.12 billion. For the current quarter, they guided for earnings of $2.35-$2.40 and analysts were expecting $2.37. For the full year, they guided for $4.23-$4.28 per share. Shares declined with the market.


Disney (DIS) is suing Redbox to halt sales of Disney movies. The company recently began offering customers codes they could use to download movies at significant discounts from prices on other websites like the Apple Music store. Disney said Redbox is violating its copyrights. Disney said it was not supplying Redbox with the codes. Redbox was buying DVD and Blue-ray packages that include the codes to give customers the access to the digital copies of the movies. Redbox takes apart the packages and sells the codes separately from the rented DVDs. Redbox was charging $14.99 for the Rogue One: A Star Wars Story and iTunes sells it for $19.99. Redbox sells some movie codes as cheap as $7.99. The DVD combo packs have a warning that the codes are not for sales or transfer. Disney is demanding up to $150,000 per copyrighted DVD sale. Redbox is no longer public. It was acquired by Apollo Global in 2016 for $1.6 billion.

Separately, Disney re-entered talks to buy parts of Fox. Comcast, Sony and Verizon are also in the bidding. Fox is considering selling its Twentieth Century Fox movie and TV studio and some international assets including its 39% stake in Sky, India's Star TV, and some cable networks, including FX and National Geographic. Reportedly, the talking price is $25 billion.


Blue Apron (APRN) CEO and co-founder Matt Salzberg resigned from the company following the prior resignation of the other founder Matt Wadiak. Salzberg will remain as executive chairman of the board. With two of the founders now out of the company, there is a small chance the management staff can right a sinking ship. Revenue growth continues to fall, average revenue per customer is declining, customers are leaving and they laid off 300 workers to narrow the drain on cash flow. The sector is very competitive with as many as 20 companies in the space including Amazon. Shares have fallen from the IPO price of $10 to $3.00.


Western Digital (WDC) is reportedly close to a deal with Toshiba in the legal dispute over the sale of their joint venture chip unit. Toshiba signed a deal to sell the unit for $18 billion to a consortium led by Bain Capital, which includes Dell Technologies, Seagate Technology, chipmaker SK Hynix and several other companies. WDC filed suit and an arbitration case claiming Toshiba was prohibited from selling the joint venture chip unit without WDC's permission. The disagreement has been in progress for about six months.

The Jiji news agency reported on Friday that Toshiba and WDC have agreed to work towards a settlement but the major sticking point is the participation in the consortium by SK Hynix. The South Korean chip company has always been a challenge because Japan does not want Hynix to gain any technical knowledge from the partnership. Letting a competitor into the business would be the equivalent of letting a spy have access to all your intellectual property. Hynix was always a problem for the Bain consortium when there were multiple companies in the bidding process. At one point Hynix was going to be regulated to "silent partner" mode and would not have had any involvement in the operations.

The settlement would have WDC dropping all objections for the sale in exchange for an extension in their joint venture agreements. I am confused as to what this means for the stock price. Obviously, they are not going to end up the owner of the other half of the venture as they had hoped but extending the joint venture agreements means WDC will continue to receive memory at cost and that will benefit drive sales. They already own 50% of the venture so nothing is going to change negatively. With shares at support, this might be a buying opportunity.


Amazon has reportedly held talks with generic drug makers about entering the drug purchasing market. Reportedly, Amazon has had discussions with Mylan (MYL) and Sandoz, owned by Novartis (NVS). The conversations were described as high level and vague. Reportedly, Amazon may be considering becoming a distributor. Sandoz president Peter Goldschmidt confirmed the meetings. There is some confusion on whether Amazon would be a drug wholesaler or a retailer of generic medications. Goldschmidt did not expect Amazon's plans to have a "major impact" on Sandoz business.

If Amazon became a distributor, the biggest competitors would be AmerisourceBergen (ABC), Cardinal Health (CAH) and McKesson (MCK). Adam Fein, president of Pembroke Consulting, a drug supply chain expert, said he did not believe Amazon would be a major threat to other distributors. The regulatory hurdles are too great and the current supply chain is strongly entrenched. In prior correspondence with regulators, Amazon has said it does not plan to store or ship drugs. That could always change. Most analysts believe it is only a matter of time before Amazon operates as an online retail pharmacy.

Amazon does not need drugs to continue making a killing in the holiday market sales. If you are a frequent Amazon holiday shopper, you know that prices shoot up after Thanksgiving. For instance, I bought a specialty flashlight the week before Thanksgiving for $35. It is $44 now with a dozen sellers. A toy my wife bought before Thanksgiving for $39 is now $52. Their low prices fluctuate wildly once the buying binge begins. Next year, plan on doing your holiday shopping before Thanksgiving.


Despite the tech wreck last week, JP Morgan is going all in on Facebook and Netflix. Analyst Doug Anmuth said Netflix continues to be our "top growth pick" into 2018. "Netflix has considerable room to expand its subscriber base and its shares are under owned compared to other FANG stocks. We believe Netflix will continue to drive and benefit from the ongoing disruption of linear TV, supported by an ever-expanding base of high quality original content." Anmuth expects the subscriber base to rise to 200 million by 2021. He raised his price target to $242 and is now the highest on the street.

His second top pick is Facebook. He raised his price target to $225 saying, "FB continued to deliver strong ad revenue growth, earnings beats and significant number revisions in 2017. We believe FB valuations are compelling at 21x 2019 EPS." Facebook has significant upside to grow Instagram's 800 million monthly users.

Morgan Stanley reiterated their $200 price target on Facebook.



OPEC and non-OPEC producers met on Thursday and agreed to maintain the production cuts of 1.8 million bpd through the end of 2018. However, they will meet in June and decide if changes can be made based on market conditions and the progress towards rebalancing. This was a compromise between Russia, which wanted a shorter commitment and Saudi Arabia, which wanted the cuts for the entire year. Investors will have to decide if this was a nine-month extension or a three-month extension with a six-month option to extend further.

The excess global inventories have already declined from 280 million barrels in May to 140 million in October. That is a significant reduction. According to the keynote address, floating storage has declined by 50 million barrels since June. The decline in inventories has helped lift prices but we are entering a seasonally weak period in the oil market until Q2 2018. With Brent prices around $64, everyone is benefitting from their production cuts but the higher prices also makes them want to sell even more oil. It will be a challenge for OPEC to keep everyone in compliance as the year progresses.


Saudi prince Alwaleed bin Talal is still imprisoned at the Ritz Carlton and has reportedly been tortured for the last three weeks. He is one of Saudi Arabia's richest men and somewhat of a rock star investor with holdings around the world. He has been called the Warren Buffett of Saudi Arabia. The Ritz has become a torture chamber for more than 200 of his fellow princes. Only a handful have been released and Prince Miteb bin Abdullah paid a reported $1 billion for his freedom. There are reports that Mohamad bin Salman (MBS), the new Saudi leader is demanding 80% of their individual net worth as a condition for their release. The torture is to learn about all their holdings. There are multiple credible reports that these princes have been hung upside down by their feet and beaten daily. Bin Talal was one explicitly mentioned as being brutally tortured. His net worth is thought to be over $17 billion. Reportedly, MBS has already confiscated more than $194 billion from the bank accounts and seized assets of those being held prisoner. The hotel itself is being guarded by the Saudi military but the interrogations are being conducted by third party contractors.

The princes are not living in the rooms but on thin mattresses on the floor of the various meeting rooms.

There is no penal code, right to an attorney, due process or civil rights in Saudi Arabia. Whatever the king decrees is the law. We sometimes forget that we are protected from many things in the US that other people worry about all their lives.



Bitcoin had a very choppy week with a $2,000 swing in prices. As of Saturday afternoon, it was $11,013. Bitcoin has made gold almost obsolete as a hedge against the dollar. Gold prices have moved very little over the last couple months while bitcoin has exploded.

New forecasts are making news on bitcoin. One analyst is predicting $40,000 by the end of 2018 and $1 million by the end of 2020. Since the supply of bitcoins is limited to 21 million because of the technology that created it, the sky is the limit on valuations.





 

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Markets

Volatility returned to the market and it is probably not over. The sudden return of volatility has reminded investors that changes in market direction can occur at any time and there is no assurance that an existing trend will continue for the rest of 2017 or even the rest of the week. When sentiment changes, it can change very rapidly.

The AAII sentiment as of Wednesday was roughly even with 35.9% bullish and 31.6% bearish with 32.4% neutral. You can bet that the survey that ends next Wednesday will be significantly different. The market event we had on Friday should have sent investors running to the bearish camp even if we have a decent rebound next week. Sharp and sudden declines tend to cause nightmares because it becomes not about losing uncaptured profits but also losing capital because of the sharp declines.


There is not a lot you can say about Friday's market other than it was extreme. We had the monster dip on the bogus ABC story on Flynn/Trump and that drove the market for several hours. As the qualifications began to appear and the story started to fall apart, the market recovered. Helping that was Mitch McConnell saying they had enough votes to pass tax reform. The positive mood began to return but it was a Friday afternoon and the weekend event risk fears began to weigh on investors.

While the vote looked promising, it would not happen until late Friday night at best and there was always the fear that another roadblock would appear. I do not blame anyone for going into the weekend flat.

Fast forward to Saturday night and the Flynn story has been completely debunked and the reporter suspended for four weeks. The vote passed and now the focus goes to the conference committee and a potential bill emerging on the 18th. Then we face the voting apprehension all over again. Next week is government shutdown week. The funding expires at midnight on Friday so all week should be focusing on getting at least a continuing resolution and at best funding for the rest of the fiscal year which ends next October.

Despite the intraday decline on Friday, the markets are still overbought. The decline may have relieved some of the pressures but it may also have damaged sentiment.

The S&P hit 2,650 the last two days and that is a psychological barrier from all the analyst targets at that level. On my analyst graphic, there is only one analyst with a target over 2,650 for 2017. There may have been some upgrades I am not aware of but you get the idea. We are right at the upper limit for forecasts.


There were a lot of stop losses erased on Friday and those investors are licking their wounds this weekend. They may not simply rush back into the market on Monday. Anyone wanting to be in the market and waiting on a dip got their opportunity on Friday.


The Dow chart became even more overbought on Thursday and Friday's dip did little to erase the optimism. There were only a handful of losers when the day was over. Boeing's $5 loss accounted for almost the entire 40-point decline in the Dow. Given the recent big gains in UNH and MMM, a minor decline at the close was pocket change. Just looking at the Dow table you would have no way of knowing the Dow was down -350 intraday. This looks like just a normal day.


The Dow is up 2,000 points since the end of September. There was a four-week consolidation pattern at the end of October and that may have removed the overbought pressures from October but now we have another 1,000 point move in the last two weeks with 675 points last week alone. Even with the positive economic and political fundamentals, that is a lot of gains without a pause to consolidate.


The Nasdaq could be our problem child next week. The index lost 41 points for the week and big cap sentiment may have been severely damaged. With the gains for the year in the big caps, there is a lot of uncaptured profit and investors may be rethinking the "hold until January" scenario on the hopes of a lower tax rate.

For the last several months about every four weeks, the Nasdaq has taken a break. The last three have been shallow and the time between events has shortened. I do not think we can claim Friday as an event since it did not close significantly lower. That means it could be the start of an event. The average decline for the last four events has been four days. Friday was the third lower low/lower high for this event. We could be due for a couple additional days of declines even if they are only minor.

Support is 6,800 and I would not be surprised to see that tested again.



The Russell 2000 fell -3% intraday or roughly 46 points. The rebound erased almost that entire decline. This is bullish for the small caps to see that violent of a reversal. If the index trades at 1,550 again, we could see an upside breakout. Small cap stocks should do well in a lower tax environment and investors may be starting to position themselves ahead of next year's results even if the taxes are not going to become effective until 2019. That remains to be seen since the effective date on the house bill is 2018 and the senate is 2019.


Volume has been very heavy over the last week. Wednesday saw 8.0 billion shares, Thursday's rally had 9.0 billion and Friday's dip and rebound traded 8.2 billion shares. Heavy volume like that normally occurs at market tops and bottoms. Since we are not at a bottom that could be a worry for investors.

Decliners were 4:3 over advancers on Friday and advancers 4:3 over decliners on Thursday. Wednesday they were almost dead even. New 52-week highs on Wednesday were 1,018 and 1,033 on Thursday. There were even 349 on Friday. What all this means is even with Friday's panic drop, the internals were not that bad and overall they have been bullish.

This can obviously change in a heartbeat as we saw on Friday. Every monstrous dip may not be bought but until that trend changes we should continue to buy the dips. The long-term fundamentals of economics, earnings and taxes will remain positive. The short-term events like a government shutdown crisis will be over quickly and the market will rebound. I am personally looking for a dip in January but that is still four weeks away. Until then, buy the dip.

Enter passively and exit aggressively!

Jim Brown

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