As more details appear on the tax bill, there are more things for the market to dislike.

Market Statistics

The tax bill is growing warts at a rapid pace. We knew about the hidden capital gains tax called FIFO or first in, first out. At the last minute, the Senate added an alternative minimum tax for corporations that will be difficult to calculate and a drag on the real tax cut. There is also the new minimum holding period of three years on investments or the gains will be considered regular income. There are some more glitches but these are bad enough.

If you have 1,000 shares of Apple that you bought half at $75 in 2014 and half at $165 in 2017 and you want to sell half to raise some cash for some other stock. Your sale for tax purposes will be considered the oldest shares. First in, first out. That means you are going to pay taxes on 500 shares at roughly $100 profit per share instead of paying taxes on $10 for the second block of $500 shares. What this does is penalize you for trading. The mutual fund industry pitched a fit and got an exemption from this bill but individuals are going to be stuck with it.

Here is how it could impact the market over the next few weeks. Investors with the problem described above may decide to sell their highest basis shares before year-end even if they do not want to sell them. The tax ramifications for holding them over December 31st are extreme. If the tax bill is passed as written, we could see a surge in selling in the last week of December.

Secondly, extending the minimum holding period for favorable tax treatment to three years is another penalty for trading. This will hit hedge funds and institutional investors as well. They will look at their holdings and determine the tax disadvantages for holding over December 31st and they could dump a lot of stock in late December in order to be taxed under the old rules.

The AMT added by the senate is even worse than the current AMT. It removes deductions for R&D tax credits and adds several onerous new rules.

The major indexes seem to be steadily bleeding points as these facts become known. The prior excitement over getting a tax bill passed is turning into frustration.

The economic reports were neutral. The ISM Nonmanufacturing Index fell from 60.1 to 57.4 for November. The ISM nonmanufacturing has only reached the 60 range four times since the financial crisis. New orders declined from 62.8 to 58.7. Employment slipped from 57.5 to 55.3. Backorders declined from 53.5 to 51.5. Business activity was only slightly lower at 61.4, down from 62.2.

Despite the decline in the headline number, this still represents economic expansion in the services sector, which accounts for 88% of nominal GDP growth. Any number over 50 represents expansion. Of the 16 industries surveyed, 14 reported increased business activity and 2 reported declines. Eleven industries were still hiring, down from 13 in October.

The international trade deficit widened from -$43.5 billion in September to $48.7 billion in October. Exports were $195.9 billion and imports totaled $244.6 billion. Petroleum imports declined $-3.2 billion. This report was ignored.

The Atlanta Fed real time GDPNow forecast for Q4 declined from 3.5% to 3.2% on the drop in the vehicle sales for November as it relates to consumer spending. That lowered the forecast for consumer spending growth from 3.1% to 2.8%.

The API oil inventories for last week saw a drop in crude of -5.481 million barrels. Analysts were expecting a decline of -3.507 million. The decline is related to two factors. The Keystone pipeline was offline for several days to repair a leak. Oil coming from Canada on the Keystone was halted. Secondly, refiners are working as fast as possible to reduce crude inventories before December 31st when they will have to pay property taxes on that oil. This is a seasonal event. Inventories will surge again in January as imports from tankers waiting in the Gulf of Mexico will begin to appear. Late December the tankers go into a parking orbit waiting for January 1st.

Gasoline inventories surged 9.196 million barrels compared to estimates for 1.145 million barrel rise. Distillates rose 4.259 million barrels compared to estimates for a 548,000 barrel build. These numbers confirm the pace at which refiners are operating. Oil prices declined about 25 cents in afterhours. The EIA report on Wednesday is the market mover if the numbers are similar.

The calendar for Wednesday is headlined by the ADP Employment report. Consensus as of Friday was for a gain of 215,000 jobs. Whisper numbers Tuesday evening for a gain of 187,000 jobs. Unless the actual number misses significantly, the report will be ignored.

The government funding deadline for Friday is going to be extended. The House introduced a bill to kick the can down the road until after the vote on tax reform. The two-week funding extension is a clean bill and has no riders. It is expected to be passed by the Senate by Friday. However, the extension is only until December 22nd and the deadline pressure comes right back again. I would strongly expect another extension into January and I am surprised they picked December 22nd since neither the House or Senate will be in session. There is something going on behind the scenes that we are missing.

Stock news was minimal as will be the case for most of December. Autozone (AZO) reported earnings of $9.96 and analysts were expecting $9.78. Revenue of $2.5 billion beat estimates for $2.54 billion. Same store sales rose 2.3%. The company said hurricane impact boosted sales by 50-60 basis points but damage reduced earnings by 7 cents. They repurchased $353 million in stock during the quarter. The store count rose slightly to 6,049. The problem with AZO is the debt and payables. They ended the quarter with payables of $4.326 billion and debt of $4.982 billion. Cash on hand was only $257 million and they had spent $353 million on stock. With nearly $10 billion in debt and only a couple hundred million in cash, they would have been better off to use that $353 million on their payables. Their stockholders equity and working capital are both negative. While the CEO bragged about their good quarter, investors were not that excited and the early gains in the stock were erased to close $50 off its intraday highs.

Homebuilder Toll Brothers (TOL) reported earnings of $1.17 that missed estimates for $1.19. Revenue of $2.03 billion missed estimates for $2.08 billion. They guided for the full year for revenue in the range of $6.24-$7.48 billion. New orders rose 14.5% to 1,979 in Q4 but that was the slowest pace in six quarters. The company guided for lower gross margin because of lower than expected home prices. What?? With prices up 7% nationwide, why are they whining about lower prices? The answer is that the high dollar homebuilder, normally building homes close to $1 million, decided to start a new line of cheaper homes tailored for millennials. This reduced their average gross margin. The average selling price still rose to $836,600 but that was below their own guidance. The number of homes sold rose 9% to 2,424. Shares fell -$3.73 on the report.

Jefferies upgraded McDonalds (MCD) saying the partnership with Uber Eats will continue to push sales higher. McDonalds has said their delivery orders have a higher average ticket than traditional on site orders. Jefferies raised the price target from $150 to $200. The company is going to restart its dollar menu in January and there will be $1, $2 and $3 items on the menu. An example would be any size drink or cheeseburger for $1, McDoubles and small McCafe drinks for $2 and Happy Meals and triple cheeseburgers for $3. Shares rose $2.34 on the upgrade.

President Trump's favorite fast food meal on the campaign trail was two Big Macs, two Fillet-O-Fish and a chocolate shake, which costs about $22 depending on the location. With the White House chefs on call, he still orders McDonalds when he can.

Restoration Hardware Holdings (RH) reported earnings of $1.04 that matched estimates. Revenue of $592.5 million missed estimates for $599 million. They guided for the current quarter for revenue of $655-$680 million. Analysts were expecting $676.9 million. For the full year, they guided for revenue of $2.58-$2.62 billion.

The earnings were up 420% from the year ago quarter. RH said the hurricanes had a 5-cent negative impact on earnings. The company completed its prior share repurchase authorization and bought back 49.5% of the outstanding shares. In 2017, they converted to a membership model and now have approximately 380,000 members and fee income rose 37% YTD. They said the membership model has eliminated the extreme promotional environment and even reduced product returns. Shares fell $8 in afterhours but recovered to close the session flat.

Unmanned aircraft maker AeroVironment (AVAV) reported earnings of 29 cents that beat estimates for 7 cents. Revenue of $73.8 million beat estimates for $62.9 million. They guided for full year earnings of 45-65 cents with revenue of $280-$300 million. Shares spiked $10 in afterhours.

Dave and Busters (PLAY) reported earnings of 29 cents that beat estimates for 23 cents. Revenue of $250 million missed estimates for $255.4 million. The company guided for full year revenue of $1.15 to $1.16 billion. Same store sales declined -1.3%. They plan to open 14 new stores in the current fiscal year. Shares rallied $4.60 in afterhours.

The big earnings on tap for Wednesday are Broadcom (AVGO). Four retailers report including LULU, TLRD, FRED and AEO. None of these should be market movers.

Disney (DIS) and Twenty-First Century Fox (FOXA) are apparently close to a deal that could be announced next week. The number being floated is now $60 billion and would include the studio and television production assets. Fox would sell the National Geographic channel, Star, regional sports networks, movie studios and stakes in Sky and Hulu along with other assets. Fox would retain the news and business news divisions, the broadcast network and Fox sports. Current shareholders would get one share of the new Fox company and shares of Disney in a currently unspecified ratio. The formal deal could be announced as early as next week. Disney shares declined $3 after Monday's $5 gain. Fox shares were flat.

Cascend downgraded Tesla to a sell rating with a $250 price target. The analyst said recent measurement of customer demand had begun to slow. Customers who have not already preordered cannot get deliveries until 2019. This allows the buying urge to fade and customers begin to look at other alternatives.

With Tesla expected to burn through $4.1 billion in cash this year and in serious need of another capital raise, there is trouble ahead. Unless Tesla can begin producing cars significantly faster, customers are going to be cancelling orders. With GM planning on producing 25 models of electric cars by 2020 and Ford announcing 15 models, the market is going to become very competitive very quickly. Tesla has had a free ride for several years and that road is about to become very bumpy.

Another analyst said Tesla is in danger of failing once the competition begins to eat into their sales and profit margins. Consumers are used to buying Ford and Chevrolet cars and once those models hit the showrooms it will become a price war. We know in advance that those companies can make enough cars to meet demand, something Tesla has never been able to accomplish. There is even talk of Tesla and Space X merging to give Tesla added cash and a technology infusion. While I doubt that will happen, it is being discussed.



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Analysts are starting to release their S&P numbers for the end of 2018 and the outlook is not good. Goldman Sachs is predicting 2,850, BMO Capital 2,950, Wells Fargo 2,700, Citigroup 2,650 and Bank of America 2,800. With the S&P at 2,650 on Monday, that suggests only minor gains in 2018. Most analysts are actually expecting a major decline in 2018 with a rebound to those numbers above.

The growing challenge is the amount of gains pulled forward into 2017 by the impending tax reform. Analysts expect an $8-$10 increase in S&P earnings and 220-270 point increase in the S&P. However, the S&P has gained 200 points over just the last three months and analysts are beginning to wonder how much of that was pulled forward from 2018.

I believe there is a significant risk of a larger than normal decline over the next 60 days. It has been 521 days since a 5% decline and we normally get those twice a year. I heard one analyst say this was the longest period ever but I cannot confirm that.

While the fundamentals remain strong with double-digit earnings, low unemployment and strong economic growth, boats can still sink in a calm sea. We never know in advance what event or headline will cause a market correction and we also know the market does not need any excuse to take profits. The rotation out of the Nasdaq stocks is a prime example. If enough portfolio managers decide to sell stocks on any given day, it can trigger a market event that convinces other managers to sell and a correction is born.

I am worried about the unintended implications of the tax bill and how that will impact the normal December rally.

The S&P peaked at 2,665 at Monday's open and has been declining ever since. Two days is not a big sell off but coming after what could be termed a blow off top, the move is worrisome.

Initial support is around 2,620 and again at 2,600.

The Dow remains very unsupported after an 800 point gain over the last two weeks and 2,200 point gain since late September. The Dow leaders are starting to lose traction and once the momentum fades, the sellers appear.

We could be in just a temporary bout of profit taking but the excitement over the tax reform has faded. The Dow is the most at risk index and the steady decline over the last two days could be the start of a larger pattern.

Resistance remains 24,500 with an ultimate target of 25,000. At this point, a sudden surge to that level over the next couple of weeks would be a very tempting sell the news target.

The Nasdaq tried to fight off the sellers today and was positive most of the day. The index has fallen back to its 30-day average which has been support since August. The break of uptrend support is negative but a break below the 30-day would be worse. The 50-day is 6,673 but that has not been a recent support point.

I had hoped the rotation out of Nasdaq big cap stocks was over but nearly all had only minimal moves today suggesting they were just barely able to hold the flat line.

The Russell 2000 fell just over 1% and was the biggest loser. The index is setting up a support test at 1,512 and a break there targets 1,500. The small caps should be leading us higher in December but it appears they have lost their way.

Bitcoin set a new high this evening at $12,111. The trend is up and there is nothing to stop it. The CME will begin trading bitcoin futures next week and the first week is likely to be a wild ride. There will be volatility!

I am worried about the market. There are cracks appearing everywhere and without another miraculous short squeeze soon, the negative trend could attract additional sellers. The S&P futures were up 3 points earlier and have fallen to -3 on news that President Trump has decided to move the Israeli embassy to Jerusalem. Multiple Arab nations have warned him not to do it and there will be repercussions. This is one more problem the market does not need at the present time.

I would recommend holding off on entering new long positions until the market finds a bottom and we have more input on what the tax bill will look like after the conference committee performs its merge of the two bills. It may look entire different when they are done.

There is always another day to trade if you have money in your account.

Enter passively, exit aggressively!

Jim Brown

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