2017 will go down in the history books as a banner year for nearly all investors.

Weekly Statistics

Friday Statistics

When you look at the weekly graphic above, the gains/losses for last week were unexciting but the YTD numbers in the center column are outstanding. The Dow may have closed the year in negative territory but gained 25% for the year. This was a great year for the Dow but it only ranks 24th in percentage terms. I looked up all the years with a 25% gain or more since 1897 and 2017 came in at the bottom. I doubt anyone reading this commentary is complaining about "only" a 25% gain.


Since the election, the Dow has gained more than 6,856 points. On Thursday the Dow was up more than 5,000 points in a single calendar year for the first time ever but Friday's selloff reduced that to 4,956. This was still the largest yearly point gain in Dow history.

Since the election:

Dow closed over 19,000 on November 22nd.
Dow closed over 20,000 on January 25th.
Dow closed over 21,000 on March 1st.
Dow closed over 22,000 on August 2nd.
Dow closed over 23,000 on October 18th.
Dow closed over 24,000 on November 30th.

The Dow reached these levels because of several stocks with monster gains. Boeing was the undisputed leader and contributed 953 points, more than twice as many as the next largest contributor, CAT at 444 Dow points. The biggest losers were GE, no surprise there, IBM, XOM and MRK. Exxon was the surprise for me but they closed 2016 at $90 and fell to $76 in August. The rising price of oil has lifted them back to $84 but the stock is still sluggish.

2017 Dow Contributors

The Dow is up 18,250 points (+282%) since the 6,469 low on March 6th, 2009. More than 25% of that gain was in the last 13 months. The index has gone nearly vertical since the election. Many claim we have reached the euphoria stage and it would be hard to argue that using this chart.


Over the same period, the Nasdaq Composite has risen from 1,265 to 6,903, or 5,638 points or a 446% gain.


The S&P has gained 2,007 points since the devilish 666 low in March 2009. That is just over a 301% gain.


The Dow was targeting 25,000 in late 2017 but the resistance at 24,850 was too strong. That resistance was likely the point where portfolio managers had decided to draw the line and exit profitable positions. Professional traders like to slip in their sell orders just before major milestones in order to beat the rush. The 25,000 level was such a large round number that it was bound to be sold when hit. There were enough sellers just under that level to prevent it from happening in 2017. I have no doubt it will be hit in 2017 but there may be some significant volatility ahead.

I personally believe the Friday sell off was prompted by one or more fund managers selling futures ahead of next week. The closing decline happened in less than 15 minutes. In that period somebody sold more than 300,000 contracts of the S&P futures. That was 56% of the day's total volume in less than 15 min. In the Nasdaq futures more than 34,000 contracts were sold which was 25% of the daily volume total. On the Russell there were nearly 8,000 contracts sold representing 39.5% of the total volume.

I will be the first to agree that some of this volume was traders jumping in front of a falling market. However, I think you will agree that given the very low market volume in the last 30 minutes ahead of a holiday weekend, the sudden unexplained spike in the futures volume is the equivalent of a smoking gun.




The markets have been trading sideways for the last two weeks. Volume has been very light and the prior momentum and excitement had evaporated. Investors and portfolio managers appeared to be holding their breath and waiting for the tax year to end.

If you were a large portfolio manager with billions of dollars of stocks in your portfolio, selling futures on Friday could have helped you in two ways. First, that would hedge you against any market decline in early January. Your portfolio would take losses but the futures gains would offset some of those losses. That would be one potential reason for the futures activity. Secondly, if that same manager knew he was going to be taking profits on a large portion of his portfolio next week, then selling the futures was a hedge against the market damage from selling out of his own portfolio. There are a lot of portfolio managers with more than $100 billion in equities under management. They all have the same problems and goals. Make money and hedge against losses.

It has been 547 days since the market has had a 5% decline. The last one was the first three weeks of 2016 when the S&P dropped -269 points. While that is not likely to happen in 2018, there is always the risk. Since that 1,810 low in early 2016, the S&P has gained 865 points or 47.8% without even a minor correction. Trees do not grow to the sky and markets always cycle. Given the recent market gains, we are due for some volatility. Next week is a likely location IF it is going to happen.


If we do see some volatility in January, I would expect it to be short, sharp and shallow. For every investor wanting to take profits in big cap techs, industrials, etc, there are probably two investors hoping for a big drop as a buying opportunity. Many stocks like Boeing have had such a big rally there has not been any material buying opportunities. If you wanted to buy Boeing, you had to close your eyes and hope you were not buying a top.

While I am dreading the next correction because I know I will lose a lot of good positions when their stops are hit, I am also looking forward to the buying opportunity. Readers should decide to either ride out the potential volatility in hopes of seeing new highs later in the year or tighten up your stops and be ready to jump back in when a bottom appears.

My only caution is this. If the stock you are holding declines 10% how long do you think it will take for it to recover that 10% and return to the highs? That is your risk. If you are trading in a taxable account, you also have to weigh the tax cost of closing the position and reopening it again.

I do not want to get too deep in the predictions here but the general consensus is that we will see higher market highs in Q1 and then a decline later in the year. Those expecting the same thing in 2017 were disappointed.

Hedgeye Cartoon

Analysts expect companies to raise guidance when they report Q4 earnings in late January, early February. They will be announcing their tax benefits, dividend increases and new stock buybacks. Investors will want to be fully invested before those earnings begin. That gives us about two weeks before the earnings begin. After the Q4 cycle, the market should be stable on expectations for the actual improved earnings in the Q1 reporting cycle in Apr/May. However, after that cycle peaks, there could be some selling of the news because all the expectations will already be priced into the market.

That analyst consensus and $5 will buy you a coffee at Starbucks but that is the only guarantee. Markets are notoriously unpredictable and rarely conform to the conventional wisdom of analysts.

One potential flaw in the scenario is the actual costs associated with the tax reform. Several companies have already reported major hits to earnings because of the way the laws were changed.

Goldman Sachs (GS) warned of a $5 billion hit to earnings in Q4 as a result of profits held overseas. Goldman and hundreds of other companies have billions in profits held overseas. Previously, they did not have to pay the 35% tax unless that money was brought back into the US. Under the new law the companies are required to pay 15.5% on that cash held overseas regardless of whether that money comes back to the US or not. It is a double-edged sword. The money can come back at a cheaper tax rate but it is still taxed even if it is left overseas. On the plus side, the law allows them to stretch out the tax payments over the next 8 years and they will not be taxed on future international earnings, within limits. This is a giant win for future earnings.


Amgen (AMGN) has warned of a $6 billion hit. Citigroup has said it expects to book a $20 billion charge against Q4 earnings and Bank of America will take a $3 billion charge against Q4 earnings.

Nobody knows how these sweeping tax law changes will impact each US corporation because it is complicated. Until companies report their Q4 earnings and guidance, it is a big unknown and investors do not like uncertainty. This uncertainty could contribute to volatility in early January.


 

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The economic calendar kicks off with a bang next week with the ISM reports and the ADP and Nonfarm payroll reports. Unless there is a major miss from the forecasts, they should not be market movers. The FOMC minutes of the Fed meeting in December, could cause some market indigestion if they appear to contradict the expectations for 2-3 hikes in 2018. Analysts have toned down their expectations somewhat and as long as the Fed is still "slow and steady" the market will be fine. The new Fed Chairman, Jay Powell, is a follower of Yellen's policies and he is not likely to make any changes to the outlook in 2018 unless the data changes dramatically.


The earnings calendar for next week is highlighted by Rite-Aid and Walgreens. Monsanto (MON) and Constellation Brands (STZ) get honorable mention. There is a trickle of earnings between now and mid January but the deluge begins on the 16th with Citi, Morgan Stanley, UnitedHealth and others. That gives us about 10 trading days between now and the 16th.


Apple (AAPL) is trying to head off the class action suits by apologizing for batterygate and offering big discounts on new batteries on iPhone 6 and later models. They are cutting the price for a replacement battery from $79 to $29. The problem arose when it was discovered Apple was cutting back processing power by 50% on older phones when the batteries dropped to less than 80%. That means everyone still using the older phones were in restricted mode nearly all the time because the older the battery the less power it will retain after a charge. They have even offered to upgrade some iPhone 6S models for free. There is a serial number check online to see if your phone qualifies.

By dramatically cutting the price of the batteries, they will blunt some of the criticism but the suits will continue. People, who got fed up with their slow phones and bought a new one to solve the problem, have a valid right to sue. They may find it will take a very long time and all they are likely to get is a discount coupon for an iPhone 12.

Apple shares are still declining after the Taiwan Economic Daily News story on slashing iPhone sales projections. It will be a month before we know the real facts but I suspect Apple shares will be sold next week by investors not wanting to take the risk of holding to see the news article proven wrong.


Netflix (NFLX) changed its pay structure for top employees as a result of changes in the tax laws. Under the old laws, salary was taxed at one rate and performance based conditional bonuses of stock at a different rate. Under the new law, there is no difference between cash salary and stock compensation so they are switching the compensation back to cash. For example, Chief Content Officer Ted Sarandos will get a raise from $1 million to $12 million in salary instead of stock bonuses. Sarandos earned $9 million in bonuses in 2017 and $4 million in bonuses in 2016, in addition to his $1 million in annual salary. He will still receive stock compensation in 2018 but under a different program.

CEO Reed Hastings will receive $700,000 in salary and $28.7 million in stock options. Chief product officer Greg Peters will jump from $1 million in salary to $6 million along with $6.6 million in stock options. I think I need to dust off my resume and send it to Netflix for chief newsletter editor and see if I can get in on that fountain of cash.


Huntington Ingalls Industries (HII) is replacing CR Bard (BCR) in the S&P-500 at the open on Wednesday. Becton Dickinson (BDX) is acquiring CR Bard leaving an open spot on the S&P-500. Scientific Games (SGMS) will replace HII in the S&P-400 and Ultra Clean (UCTT) will replace SGMS in the S&P-600.


Tivo (TIVO) reportedly has received multiple expressions of interest from private equity firms to take the company private at just over $20 a share. Shares were trading at $14 before the news broke. Tivo merged with digital entertainment guide provider Rovi Corp in a $1.1 billion deal in 2016. Rovi paid $10.70 per share for Tivo and then kept the Tivo name and symbol. In their last earnings they had $310 million in cash and marketable securities and a market cap of less than $2 billion. This is a very competitive space with companies like Comcast and DirecTV marketing their own DVR products and other companies like Hulu, Amazon, Apple and Google offering over the top streaming services. In December Tivo made a deal with cable operator Altice USA to support their digital offerings. Tivo recently won an International Trade Commission battle against Comcast violating two of Tivo's patents.


Crude prices continue to rise as US inventories decline. Libya said they would begin repairing the damaged pipeline sometime next week. The pipeline was blown up by a rival militia to halt the export of oil. The pipeline carried 90,000 bpd. The pipeline is expected to be back in operation by mid January.

US oil production fell -35,000 bpd last week to 9.754 million bpd. That is the first decline in 8 weeks after posting 7 consecutive weeks of record production.

The active rig count declined -2 to 929. Gas rigs declined by 2 and oil rigs were flat at 747. Seaport Energy said last week there were a record number of drilled and uncompleted (DUC) wells in the US at 7,300. With that kind of backlog there is no reason to activate additional rigs. Add in the holiday disruption and there are not likely to be any rigs added next week.

The analyst consensus is that prices will decline in early 2018 and then rebound into the summer. The problem ahead is the potential for the OPEC production cut to be weakened or eliminated in July. The various global outages have helped to accelerate the global inventory decline and Russia is expected to balk at having the cuts extend past the end of June. Saudi Arabia is expected to fight to keep the cuts in place because of their pending IPO of Saudi Aramco. They need oil prices as high as possible to get the maximum price for their IPO. However, many investors have backed away from the deal after Mohammed bin Salman (MBS) arrested more than 200 people including more than 100 princes in order to solidify his grip on power.

He has been charging these people enormous sums of money to gain their freedom. MBS is reportedly demanding $6 billion from Prince Alwaleed bin Talal, the famous international investor. He is worth an estimated $18 billion but is refusing to liquidate and pay the fine because he has done nothing wrong. If he pays the fine, it would be an assumption of guilt and would hurt his future business dealings.

International investors are backing away from the Aramco IPO because they have been reminded there is no rule of law in Saudi Arabia. Whatever the king wants to do, he does, even if it causes problems in the business community.


Markets

The S&P has been moving sideways and Friday's close was a two week low. There is strong resistance at 2,692-2,694. Support is well below at 2,650 and 2,625. A minor 5% decline would target 2,550 and that is well below Friday's close. The biggest dip we have seen since January 2016 was a -3.1% drop. The market is very overdue for some profit taking. I think everyone would agree that a 5% decline would reset the overbought conditions and allow a new rally to begin. A 3% decline would be 2,610.

The Santa Rally has two more days to run. The S&P needs to close above 2,685 on Wednesday or the rally will have failed. "When Santa fails to call, the bears will come to Broad and Wall."

The S&P saw 62 days with a record high in 2017.


The selling at the close was very broad and that also suggests it was futures related. The Dow declined to just above short-term support at 24,720. A break below 24,700 should trigger additional selling with an initial target of 24,100. A 3% decline would be to 24,092 so that 24,100 support should be critical. A 5% decline would take the index to 23,600. The resistance at 24,850 remains very strong and has been an immediate stop with every test.

The Dow posted 71 days with a record high in 2017.



The Nasdaq has been the weakest index. The big caps have been choppy with a downward bias with the exception of only a couple stocks. The index closed at a two-week low and below initial support. The 6,785 level would be a 3% decline with a 5% drop at 6,650. With Apple on the edge of a breakdown and the chip sector negative for the last several weeks, the Nasdaq could be the index that leads the market lower. Tech stocks are not going to benefit from the tax reform as much as industrials. Techs have the lowest effective tax rates of all 10 S&P sectors. This could cause some selling next week as investors rotate into tax benefit sectors.

The Nasdaq Composite had 72 new highs in 2017. The index has been up for six consecutive years and has not done that since the streak in 1975-1980.

The Nasdaq 100 is now up for nine consecutive years and that is a record.




The Russell 2000 tried valiantly to break through the strong resistance at 1,550 but did not succeed. Friday's close was a two week low. A 5% decline would take the index to 1,471 and a 3% drop would target 1,502. That is a nice round number that has been defended in the past.


If the retail herd is normally wrong about direction, the AAII survey results are a bad omen. Bullish sentiment has not been this high since November 13th, 2014. Bearish sentiment has not been this low since November 4th, 2015. Bullish sentiment has risen 23.3 points since the recent bottom at 29.3% on November 16th. Historically, when sentiment has been this high the market under performs in the six months that follow. Obviously, there are fundamental factors that should support the market over the next four months and that is why bullish sentiment is so high. That does not mean there will not be a counter reaction to this bullish move.


This was the fourth consecutive year that the S&P has declined on the last day of December. In 2014, the S&P declined 21 points on the last day and continued to decline another 87 points on the three days that followed for a total drop of -108 points. In December 2015, the S&P declined 20 points on the last day and continued to decline another 231 points in the 12 days that followed. In December 2016, the S&P declined -10 points and then rebounded 43 points over the next four days. Just because the last day of trading is negative, it does not mean the next week will be negative. In December 2013, the last day was positive but the S&P still declined -31 points over the next 8 days. Then, after a week of minor gains, the index fell -103 points over the next 8 days.

If this minor bit of research tells us anything is that January has posted losses more often than not in recent years. 2012 was the exception. After a -27 point drop in mid December 2011, the S&P rocketed higher in January for a 214-point gain through the end of March.

There are exceptions to every trend. Hopefully, January 2018 will be an exception and the market will continue higher. Unfortunately, hope is not a trading strategy and we need to be prepared in case the markets take a needed rest. Be prepared with cash in your account to buy the dip. Actually, I prefer to say buy the rebound because picking bottoms is a dangerous way to trade. Look for a strong rebound on decent volume and then enter your new positions. Entering too late is always preferable to entering too soon.

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