Potential negative headlines are evaporating one by one, as the market prepares to close out the year on a high note.
The tax bill was passed and signed and it no longer a potentially negative headline. In fact, it may turn into a once in a generation event for the market. The government-funding deadline was kicked into January as lawmakers opted for another continuing resolution rather than remain in Washington over the Christmas holidays and fighting over a government shutdown. That was another potentially negative headline that evaporated on Friday. The event horizon is now clear of potential problems until the new January 19th funding deadline.
The market is free to move in any direction it chooses over the next couple weeks without any political roadblocks. So, how did the market celebrate on Friday? The Dow dropped at the open to trade down -64 points intraday and move slightly farther away from the 25,000 end of year target.
The small cap Russell 2000, the index that should be leading us higher in December, fell -7 points intraday and slipped farther away from the strong resistance at 1,550.
I believe the market is going to have a banner year in 2018, assuming there is no black swan event, but it may suffer a rough start. The normal Santa Claus rally is the last 5 days of December and the first 2 days of January. Everyone that has been actively trading for any period of time knows to expect gains over the next six trading days. Friday was the first day of the rally but it did not turn out very well.
The Santa rally is thought to be caused by retail investors putting their holiday bonuses to work in the market. Investors are home for the holidays with money burning a hole in their pocket. The first two days of January are normally expected to rise because of year-end retirement contributions hitting those mutual fund trading desks. Since 1896, the Dow has risen 76% of the time over these 7 days. There is also a market saying about the lack of a rally. "If Santa fails to call, the bears will roam on Broad and Wall."
If the next 6 days are normally bullish, why was last week so lackluster? Earlier in the week, it was all about the passage of the tax reform bill. Uncertainty kept the markets in check. On Friday, there was no obvious reason for weakness other than lack of interest and weak volume. Investors and traders were at the mall or home getting ready for that weekend visit to mom's house rather than huddled over their monitors trying to trade stocks. Volume was only 4.8 billion shares and I am surprised it was not lower. Maybe the investor mindset will change next week once all the gift giving and family gatherings are just a fond memory.
There remains a lot of uncaptured profit in the market and once the calendar turns over into 2018 and lower taxes, a lot of that profit could be taken and put to work in different stocks where the corporate tax cuts will be more beneficial. This is the current risk for the market. In 2016, the S&P lost 269 points in about three weeks after hitting new relative highs in December. I am not predicting this for January but it is always a possibility. I definitely do not think we could have a similar major decline because of the once in a generation windfall profits that will begin hitting the earnings guidance in January and the actual earnings in April. This will be a gift that keeps on giving for investors.
However, we could still have a decent dip. I believe it will be a buying opportunity and it could be short, sharp and shallow. We need to be prepared and that means not being fully invested on January 2nd. Keep some cash in your account just in case an opportunity arises.
As of Thursday, the Dow was up 38.6% since the election. The Nasdaq is up +37.9% and the S&P +28.7%. Nobody in his or her right mind would expect the market to continue higher without a decent dip in the coming weeks.
There was a flurry of economic data on Friday. Most of it was positive. Personal income rose 0.3% in November and slightly under the +0.4% expectations. Income is now up +3.8% on a year over year basis. These numbers will rise sharply in 2018 as a result of the tax reform. Personal spending rose +0.4% and the second highest rate since March. The impact of the hurricanes on the data has produced some significant volatility over the last three months. This number will also surge as consumers get more money in their paychecks.
The PCE Deflator, the Fed's favorite inflation indicator, rose +0.2% in November. Most of the gains were related to the 7.0% rise in gasoline after the hurricanes. Goods rose +0.3%, durable goods declined -0.2% and motor vehicles rose +0.3%. Services rose 0.2% and healthcare +0.1%. The core PCE excluding food and energy rose only +0.1%. On a trailing 12-month basis the PCE is up +1.8% and the core PCE is up 1.5%. Inflation remains contained.
Durable goods orders for November rose +1.3% after a revised -0.4% decline in October. Excluding transportation, orders declined -0.1%. Nondefense capital goods orders rose 2.6%. Shipments rose 1.0%. This report was ignored.
The final revision on Consumer Sentiment for December declined from 96.8 to 95.9. Analysts were expecting a rise to 97.1. The decline was caused by a drop in the expectations component from 88.9 to 84.3. The present conditions component rose from 113.5 to 113.8. Despite the decline in the headline number the trend is still higher and once those lower taxes begin hitting consumer paychecks, we should reach a new high.
New home sales for November rose 17.5% from 624,000 to 733,000 on an annualized basis. That was 27% higher than November 2016 and it was the highest month since July 2007. The supply of homes on the market fell from 5.4 months to 4.6 months and the lowest since July 2016. There were 283,000 new homes listed for sale at the end of November, up 23% from 2016. The median home price rose 1% to $318,000. Homes priced under $300,000 made up 45% of the total.
The Kansas Fed Manufacturing Survey for December declined from 16 to 14. New orders declined from 22 to 7 and inventories fell from +2 to -11. Backorders declined from 12 to 6. Anything over zero is expansion so the Kansas area is just expanding at a lower rate. The tax cuts will likely help as manufacturers add more capacity and additional products using the free cash flow from the reduced taxes.
The decline in several of the week's economic reports pushed the Atlanta Fed's GDPNow forecast for Q4 back down to 2.8% from the 3.3% forecast on Monday. The personal spending reduced expectations by -0.2% and the durable goods knocked off another -0.3%. This is a volatile real time forecast so the numbers change weekly.
We have a skinny calendar for next week. The Richmond survey and the pending home sales are the most important. There are no earnings next week.
You probably heard that bitcoin imploded on Friday. The coin hit $19,900 on Sunday and then crashed to $10,400 on Friday. This chart from World Coin Index does not show the $10,400 low because that was on Coinbase. The CME futures do not show it as well because the futures were limit down for a long time. On the CME, there is a trading halt at 7%, 13% and 20% move intraday. If it hits the 20% number on a decline, it cannot go any further that day. The futures can trade higher but they cannot trade lower. That is a killer if the futures are limit down as they were but the coin is trading $2,000-$3,000 lower on some other exchange. On the CME chart, the flat lines are trading halts. The various exchanges have a lot to work out before the coin will actually be liquid without extreme volatility. On the last chart, note how the volume surged after the lows on Friday.
CME Futures Chart
World Coin Index Chart
Nvidia (NVDA) traded sharply lower intraday because of the drop in bitcoin. People need to realize that Nvidia receives no material revenue from bitcoin because it is no longer mined on Nvidia GPUs. Everyone seems to panic whenever bitcoin crashes and they think the Nvidia rally will end. Nvidia is on track to do nearly $15 billion in revenue in 2018 and their revenue is rising about 35% per quarter. In their last earnings call, the CEO downplayed the revenue from all crypto currency mining saying it was less than $80 million out of their $2.65 billion quarter. That would not move the needle even if all $80 million suddenly evaporated because revenue rose $687 million in Q3. Investors need to get over this unrealistic idea that Nvidia is only about crypto currency mining.
Rosenblatt Securities reiterated a buy on Friday with a price target of $250. The analyst said we may look back a year from now and realize that target was too low.
Shake Shack (SHAK) was downgraded by Jefferies to underperform (sell) and a price target of $36. That would be a 22% decline from its current price of $45. The analyst said SHAK may have a bright future but that is already priced into the stock after the latest rally. SHAK shares have a PE of 71 compared to McDonalds at 26. SHAK has 114 stores and McDonalds has 31,230 stores. He also said store traffic is likely to be negative in 2018 due to store cannibalization, high initial volume and a small comp base. SHAK is finding that when they open stores away from the Northeast the volume on those new stores is lower because of traffic density and price points. You can sell a $10 burger in NYC but the same burger in a southern store would be $6. Shares fell 3% on the downgrade.
Jefferies also upgraded the price target on Dunkin Brands (DNKN) saying the company will get a huge boost from the tax reform. Dunkin currently pays about 38% in taxes and that will fall to 21%. The analyst said this would represent an 18% upside to earnings above current estimates for 2018. Many of the franchisees would see the 20% deduction for pass through businesses. This extra free cash flow would allow the company to increase its capex spending in addition to the recent spending announcements. This would provide additional funds for advertising and marketing. They price target was raised from $60 to $68 but shares were already trading at $65.
Apple (AAPL) is now facing several suits for issuing software updates that deliberately slowed response times on older phones. Apple said it was to reduce the load on older batteries that could have been weaker as a result of being recharged hundreds of times. Apple never told users their phones were being progressively slowed, leading them to think the only way to resolve their sluggish phone problem was to buy a new one. Basically, Apple was slowly degrading their phones to the point where an upgrade was the only option. Customers could have just replaced the battery if Apple had told them it was an issue. Apple had recently sent out the software downgrade to owners of iPhone 7s, a relatively new model. Software detectives struggled to find out why their phones had slowed and eventually found the slowdown code. Analysts said the lack of disclosure is what makes it appear criminal. If they had told users about the downgrade and why, with the option to downgrade or not, it would not have been a problem. Now that millions of users have upgraded when they did not really have to, it may cost Apple a lot of money.
For years, it was theorized that Apple had a "kill switch" in its phones that would be activated after 18-24 months to degrade operations and force an upgrade to a new model. These people were considered conspiracy theorists and now they have been proven right.
Analysts are starting to lower their Q4 expectations for iPhone sales. The X is now available in stores for immediate delivery in the US and UK. The surge in sales has faded but it is expected to be steady for the next two quarters. Some carriers have been offering a buy one, get one free promotion for iPhone 8s, suggesting those are not flying off the shelves either.
Apple shares could see some weakness in January as investors take profits from the 2017 gains. That might be the wrong idea since Apple's $265 billion in overseas cash will be eligible to come to the US at a tax rate of 15.5% instead of the 2017 rate of 35%. A lot of that cash will likely be used for stock buybacks and big dividends for Apple shareholders. Both of those options would boost the stock price. It might be worth enduring a little pain in early January in return for long-term gains. Apple is likely to announce its cash repatriation plans with the Q4 earnings on February 1st.
Insurer Chubb Ltd (CB) authorized a $1 billion stock buyback for 2018. The company is trying to defend its stock price while at the same time defending hundreds of homes and businesses insured by Chubb in California. Chubb has even contracted with private firefighters across 13 states to protect homes in danger from wildfires. Chubb sent 11 fire trucks with private firemen to protect more than 500 insured homes from the Thomas fire in California. The idea is that it is cheaper to protect a home instead of rebuild it. One specific home had seen visits from the fire teams on five separate occasions since the fire started. The team installed sprinklers, cleaned out gutters, taped vents shut and removed patio furniture that could have caught fire. On one visit, they found fire already on the property and they put it out before installing hydrating gel in potential risk areas.
This is a great idea for homes still intact but with this kind of active management you have to wonder how many of the more than 1,000 homes destroyed were insured by Chubb. With shares declining, it suggests some investors are not waiting around to find out.
Boeing (BA) is reportedly in talks to take an equity stake in Brazil's aircraft manufacturer Embraer SA (ERJ). Brazilian president Michel Temer said he would veto any complete acquisition but would be open to an injection of foreign capital and a working partnership. The government has what is called a "golden share" of Embraer and enough voting rights to block any transaction. Temer said he would block any plan that gave Boeing control over the military component of the company. Embraer, like Boeing, makes commercial planes as well as military attack and transport aircraft. Embraer is one of the few Brazilian companies that is profitable internationally. The company is preparing to build the Gripen fighter jets with Sweden's Saab AB. They also have a military transport project called the KC-390, which seeks to take over the military transport market previously dominated by the US Hercules C-130. Boeing already has a marketing deal with Embraer on the KC-390. Boeing will help market the plane and then provide support services once they are sold.
With Airbus taking over the production of the small Bombardier C-series commercial jets, Boeing needs the similar aircraft that Embraer produces. This would fill a hole in Boeing's product lineup and be far cheaper and faster than designing, building and testing their own models. A joint venture with Boeing on the commercial jets would instantly give Embraer a global marketing force and the implied stability of Boeing as a partner.
Wells Fargo (WFC) has changed their tune on the market outlook after the passage of the tax reforms. Analyst Scott Wren had been one of the most cautious with predictions of a 4% to 8% pullback and call for a recession in 2019. He has reversed his forecast and currently expects the S&P to reach 2,700 in 2018. That is hardly bullish and Wren said he is currently reworking his numbers because the actual tax package for corporations was more aggressive than previously expected. Now he believes we could see a gain of 10% or more in 2018 but he has not finalized that forecast for 3,000 just yet.
Citi has bumped their estimate to 2,800 and Credit Suisse to 3,000. Canaccord Genuity is currently the highest at 3,100 with JPM at 3,000, UBS 2,900 and GS 2,850.
The passage of tax reform has caused a sudden surge in companies trying to share the wealth with their employees. AT&T said it was giving more than 200,000 employees a bonus check of $1,000 and would increase its capex budget for 2018 by $1 billion. Fifth Third Bancorp (FITB) said it would give more than 13,500 employees a bonus and raise the minimum wage to $15 an hour. Wells Fargo (WFC) said they were boosting the minimum wage to $15, giving employees a bonus and would target $400 million in donations to community and nonprofit organizations in 2018.
Sinclair Broadcasting (SBGI) said it would pay $1,000 bonuses to 9,000 employees. Bank of America (BAC) said it would give $1,000 bonuses to about 145,000 employees in a spirit of "shared success." Western Alliance (WAL) said 900 workers at the regional bank would receive a 7.5% raise on top of their normal annual increases. Boeing (BA) said it would put $300 million into charitable giving and workforce development training to improve the income of its workers. Arizona Public Service said it would pass on the benefits from the tax cuts to its customers in the form of discounts on their bills.
Starbucks said they were not going to pass on the tax benefits to its employees. The official said Starbucks was the first retailer to offer full healthcare benefits even to part time workers and tuition free 4-year degree through the College Achievement Plan. They already have employee stock ownership plans, bonuses and high wages. This might not go over well with the rest of the left coast since they see Starbucks as leader in the fight to improve worker wages.
Southwest Airlines (LUV) said the benefits would allow them to upgrade their fleet and they would share the gains with their employees. Comcast (CMCSA) said it would pay a special bonus to more than 100,000 employees and invest more than $50 billion in infrastructure over the next five years.
FedEx said it would boost capital spending and hire new employees to accommodate the expected increase in package traffic from the economic growth the cuts will promote. Kansas City Southern (KSU) said it would pay a $1,000 bonus to its employees. Rush Enterprises (RUSH) will give a $1,000 bonus to 6,600 employees.
This was just a few of the early reporters planning on sharing the tax proceeds with their employees. This will boost consumer spending in January and once the tax cuts begin in February for everyone, we will see spending surge again. There is a large percentage of the country that does not believe the cuts are real or that it will impact them. It will be interesting to see how the economy performs in Q1/Q2 as all the corporate and consumer benefits begin to appear. In this case, trickle down, should actually work.
Crude prices are starting to tick higher as inventory levels post a seasonal decline. Currently there are about 1.95 million bpd of production outages in addition to the 1.8 million bpd in voluntary cuts by OPEC and Russia. OPEC outages are roughly 350,000 bpd and non OPEC outages of 1.655 million bpd. This includes the 450,000 bpd Forties pipeline that is currently down for repair in the North Sea. The pipeline repair is expected to be completed next week but will not return to full service until mid January. The outage is expected to remove 13-15 million barrels from global inventories.
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For a normally bullish week, the markets lost ground the last four days. The new highs on Monday should have galvanized all the bullish procrastinators into action but all we saw after Monday's open was light selling.
Bank of America said investors pulled out $14.5 billion from equities for the week ended on Wednesday. That was the fourth largest withdrawal on record and the most since the week after the Brexit vote. High yield bond funds saw outflows of $5.3 billion and the biggest in the last year. This was the eighth consecutive week of outflows. Regular bond funds saw outflows of $3.2 billion and the most in a year. BAML said funds exited financials, small caps and value funds. US value funds had outflows of $7.8 billion and small caps lost $5.8 billion, both of those were the most in a year. Those are all sectors that should benefit from the tax cuts. This appears to be a prime example of a sell the news exit on the thoughts that the cuts are fully priced into the market.
A couple weeks ago, I might have gone along with that "all priced in" thought. However, the more I research the potential impact, the more I am convinced we are going to have a good year in 2018.
The new highs on Monday and the limited selling through Wednesday saw another 5.5% of investors convert to a bullish outlook on the AAII survey. This survey ends on Wednesday so there may be fewer bulls today. The last time bullish sentiment was this high was on January 1st, 2015. This is only the 11th week this year that bullish sentiment has been over its historical average of 38.5%. Neutral sentiment has collapsed to only 23.9% and the lowest level since March 9th.
Bullish sentiment hit a bottom on November 16th at 29.3% and has risen for five consecutive weeks. Since the low, bullish sentiment has risen 21.1 points and bearish sentiment has fallen 11.6 points. Bullish sentiment is unusually high and more than one standard deviation above its historical average. Typically when sentiment is this high the market is lower 6 and 12 months later.
I understand why sentiment is breaking out to the upside because we are facing a once in a generation event with the massive corporate tax cuts and earnings boost. That may mean there will be no ill effects in the short term but by the end of Q2 all of the benefits will be priced into the market and the normal summer doldrums could be especially rocky.
The S&P can still reach its year-end target at 2,700 with only a couple decent days. The high was 2,695 on Monday and 2,694 on Tuesday. The index closed 17 points below that level on Friday. The week after Christmas is normally bullish. I think you would agree this is not a normal year. None of the bearish historical trends have worked this year but several of the bullish periods have cooperated. That is not hard to believe with the S&P up 28.7% since the election. It has been one long bullish trend.
Short-term support has appeared at 2,679 with stronger support back at 2,650. If we drop back that far we have bigger problems. The 2,625 level would be the next pause point.
The Dow was listless on Friday for obvious reasons. The lack of volume allowed the few sellers to control the tape. The index target for December is 25,000 but the close was -246 points below that goal. The Dow could still ring that bell at the top but I would expect it to be a fight. The Dow failed at 24,850 on four consecutive days last week. That has turned into serious resistance. Support is around 24,715 and not very defined. A decline below 24,700 could trigger additional selling because it would signify the rally was over for 2017.
If the Dow were able to tag 25,000, I would expect the mother of all sell the news events. That number is so large and so visible, the shorts would be falling all over themselves to short it and the bulls would be taking profits with the obvious target reached. A funny thing happens when a target is hit. If there is no obvious second target, the market loses traction because traders do not know what to do.
The Nasdaq big caps would appear to be evenly matched between the advancers and decliners but the decliners posted bigger losses. Despite those declines, the Nasdaq only lost 5 points on low volume. That is the equivalent of a goal line stand at 6,950. The Nasdaq closed at the low for the week but still gained 23 points for the week thanks to the Monday spike to a new high. The Nasdaq traded over 7,000 intraday on Monday and that was the unofficial target for the month.
The big cap stocks are still showing signs of weakness. Their charts are choppy and more than half closed at the lows for the week. This does not bode well for the rest of the year. They could recover sharply on Tuesday in a normally bullish week but resistance at 7,000 is likely to be strong.
The Russell is still battling resistance at 1,550 but it has a nice pattern of higher lows for the week. This could suggest the Russell will lead us higher next week but I would not count on it. Having the Russell take leadership to the upside could create a broad market rally.
I am neutral for next week. The charts are projecting weakness but nothing that could not be corrected by one good application of bullish sentiment. I am sure there are a lot of shorts already locked and loaded and a sudden surge higher could force them to capitulate.
I would rather not try and predict next week and focus on what to expect in January. The market action next week will be on low volume and that could either increase volatility or turn the market dormant like it was last week. I believe the big cap tech stocks will give us direction. If they appear to weaken further it would suggest sellers are increasing for January. I would also watch Boeing, Caterpillar, Home Depot and McDonalds. Those have been the Dow leaders. If they begin to fade next week, I would expect them to sell off in early January.
If you do not have to be in the market this week, I would recommend watching from the sidelines. It is the next week that will be important. This week is the pregame warm-up.
I would like to take this opportunity to wish everyone a very Merry Christmas. 2017 was our 20th anniversary of producing this newsletter. We started on Thanksgiving weekend 1997. We still have quite a few subscribers who have been with us since 1997 and I thank you for your continued support. We did not archive all the newsletters from the very start but every newsletter starting in 1998 is on the website. You can always go back at any time and read the market commentary for any day where critical events occurred.
I had another anniversary in 2017. I celebrated my 50th wedding anniversary and I could not have produced the newsletter for the last 20 years without the support of my wife.
We would both like to thank you for your continued support and wish you a Merry Christmas.
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"For the past 50 years or so I have been getting more and more worried about Christmas. Seems we are all so busy trying to beat the other fellow in making things go faster and look shinier and cost less that Christmas and I are sort of getting lost in the shuffle."
Kris Kringle aka Santa Claus, "Miracle on 34th Street" (1947)
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