The bulls are stampeding and the bears are getting trampled.
The last four days were a great start for 2018. Actually, if the percentage numbers in the first graphic were for the full month of January it would still be a great start for the year. Investors are throwing money at the market and there are no signs of selling. The worries were unfounded over an early January bout of profit taking. Other than a few stocks that sold off hard at the open on Tuesday there was no broad market selling. Most of those that did sell off hard at the open rebounded before the day was out.
All the major indexes closed at new highs but the Russell was struggling once it punched through the 1,550 resistance level. While the big cap indexes were surging the Russell put in consecutive 2,3 and 4 point gains starting on Wednesday at 1,552.
Since mid October, with the exception of two weeks in mid November, the big caps have sharply outperformed the small caps. Since October 17th, the Dow has gained 9.9% while the Russell has only gained 4.2%. In theory, December is supposed to be a strong month for small caps but they declined the first two weeks. If the Russell were to accelerate higher next week, this broad market rally could really catch fire ahead of earnings.
On the AAII Sentiment Survey for the week ended on Wednesday, which was before the Dow hit 25,000, the bullish optimism spiked to 58.8% and the highest level in 7 years. The last time sentiment was this bullish was December 23rd, 2010 at 63.3%. The historical average is 38.5%. Bearish sentiment at 15.6% was the lowest since November 6th, 2014 with the historical average 30.5%.
In the 30-year history of the survey, there have only been 46 weeks with bullish sentiment at this level or higher.
It does not take a rocket scientist to figure out that euphoria is overtaking the market. If the herd is normally wrong about market direction then we have trouble ahead.
However, there are so many favorable factors impacting market sentiment, I do not see a major decline ahead. Consider these points.
Earnings are rising.
Economy is improving.
Global economy is rising.
Major corporate tax cut.
Individual tax cut for 80% of population.
Low interest rates.
Fed slow walking rate hikes.
Unemployment at 17-year low.
No material inflation.
Business regulations evaporating.
Obviously, the market does not need an excuse to take profits but now that we are out of the first week of January, it is not likely to happen until after Q1 earnings. The first week of 2018 was always the biggest risk but analysts have turned so bullish that investors would be crazy to dump stocks ahead of earnings.
The key point is that companies will give new guidance based on the impact of the tax reform on their earnings. We could see some dramatic earnings upgrades.
Analysts have started calling the market fairly priced where they were calling it expensive a month ago. The difference is the $10-$12 expected gain in S&P earnings to $145 or even $150 according to some analysts. The problem is that applying a PE of 18 to the $145 number and you get 2,610 for the S&P. If you take the top estimate at $150 x 18 you get 2,710 and we are already well over that level.
If you take the most optimistic S&P target on the street, which is Yardeni and Associates at 3,100 and the most optimistic S&P earnings target at $150, that translates into a PE of just under 21 and that is not cheap. Yardeni said this was a classic FOMO (fear of missing out) market.
Eventually, the estimates on earnings and the forecast for the S&P, will have to be reconciled. That is likely to happen after the first three weeks of Q4 earnings when we will have the majority of the new S&P guidance. If that guidance comes in at the $145 level or lower, there will be pain in the market because that will not support a PE of 21.
Fortunately, we have several weeks before the estimates begin to firm up and the bulls are currently in charge. The only obvious pothole ahead is the potential for a government shutdown on the 19th. That is two weeks away and could cause a volatility event if it happens or a positive uptick if it gets resolved in advance.
On the economic front, we are starting to see some slowing. It is not material, yet, but it does exist. This could be the result of weather except that until the last couple of weeks it has been unseasonably warm. It could be residual impacts from the hurricanes but those should be translating into an increase of activity related to rebuilding and replacing items that were destroyed. Temporarily, I am going to chalk it up to just a normal cycle of ebb and flow until it becomes a trend.
The nonfarm payrolls for December came in at 148,000 and well below the consensus estimates for 188,000 and the whisper number at 210,000. The whisper number had risen after the ADP Employment report on Thursday came in hot with a gain of 250,000 jobs compared to estimates for 190,000. The December headline number will likely be revised higher next month.
There was a decline of 9,000 jobs in the revisions. November was revised up 24,000 from 228,000 to 252,000 but October was revised down -33,000 from 244,000 to 211,000. The three-month moving average is now 204,000.
The unemployment rate remained at 4.1% for the third consecutive month. Only 64,000 people joined the labor force and the participation rate was flat at 62.7% for the third consecutive month.
For all of 2017 the economy created 2.055 million jobs, down slightly from the 2.24 million in 2016. It is becoming harder to raise that number since we are effectively at full employment. There are plenty of available jobs but there is a lack of skilled workers. Employers are being challenged to find the most qualified applicant and then provide additional training to bring them up to the level required for the job. Over the long run, this is beneficial for the economy because it means the skills level for the labor force is rising and the average wage will rise as well. This will increase consumer spending and fuel the economy.
Highpoints included 55,000 new goods producing jobs with 30,000 in construction and 25,000 in manufacturing. Education and healthcare added 28,000. The retail sector declined -20,000 with the majority attributed to general merchandise stores.
The ISM Nonmanufacturing Index for December declined from 57.4 to 55.9 with the business activity index falling from 61.4 to 57.3. New orders fell from 58.7 to 54.3. Nine industries reported growth in orders and seven industries reported a decline. The decliners were IT, mining, wholesale trade, educational services, professional services, management support services and construction. The employment component rose slightly from 55.4 to 56.3. The service sector now accounts for 88% of GDP. Any number over 50 in the ISM represents expansion so we are still moving in the right direction but at a fractionally slower pace.
Respondents reported an increase in lumber prices because of the fires and an increase in steel prices because of duties on Vietnam. They were also positive because of an increase in activity in the oil and gas sector that was generating additional service activity.
Factory Orders for November rose 1.3% after a 0.4% rose in October. This was the fourth consecutive rise in orders after a -3.3% drop in July. Durable goods orders rose 1.3% and nondurables 1.4%. Nondefense capital goods excluding aircraft declined -0.2%. Defense orders rose 4.9%. Shipments rose 1.2%. The components important to GDP saw upward gains and that should boost Q4 GDP estimates.
The Atlanta Fed real time GDPNow for Q4 declined from 3.2% growth to 2.7% because the decline in job growth blunted expectations for consumer spending in Q4. The decline in the ISM Services also impacted the forecast. The next update to the GDPNow will be Wednesday.
The economic calendar for next week is pretty busy with the most important report the Philly Fed Manufacturing Survey. This is the most important of the regional reports. The PPI and CPI will be the inflation indicators and the retail sales for December will be important but we already know it was a good holiday shopping season.
The earnings begin to flow on Friday when JP Morgan Chase, Wells Fargo, Blackrock and PNC Financial report their results. That will set the stage for the rest of the financial sector.
Nineteen S&P companies have already reported for Q4. That is a small sample and may not be representative of future results. This is especially true since these companies reported either before the tax vote or too soon afterwards to give comprehensive post reform guidance for 2018. Of those 19 companies 79% beat earnings estimates with 89.5% beating revenue estimates. Q4 earnings estimates are currently 11.4% growth with revenue expected to increase 6.9%. To date there have been 69 earnings warnings for Q4 compared to 42 companies giving positive guidance. There are 7 S&P companies reporting earnings next week and one Dow component (JPM).
Companies giving positive guidance on Friday included KIDS, DPLO, ASGN, OLLI and SIMO. Companies giving in line guidance included STZ, RTIX and GBX. The only company guiding lower was CORE.
The big stock news for the week was a hit to Intel (INTC) after researchers found not one but two major flaws in their chip logic, which would allow hackers to steal user data from unprotected PCs, Macs, notebooks, laptops and smartphones using Intel chips. Any computer produced over the last 20 years was at risk. The two logic flaws were named Meltdown and Specter. Basically, malicious code in an unprotected operating system, could read what was stored in system memory. This was supposed to be protected but under the right set of circumstances, malicious code could extract that information which could include passwords for the system that would allow hackers to come back in with valid login information.
Intel and Microsoft had already put out a series of software patches and browser updates to resolve this hole in the operating system. However, major companies were reluctant to just apply fixes to everything because of the potential errors in the patches. Whenever a fix to a major problem is rushed to the market over several days, there can be unexpected results. The patches are written for normal operating environments. In the real world with more than two billion servers and PCs worldwide, there are lots of operating environments that are not "normal" and they have to test the patches before applying them. Major companies typically have a broad range of operating systems from Windows XP and Windows 2003 server to the latest versions of each. Every system has its own unique update history.
Of course, Intel and Microsoft are urging customers to upgrade to the latest version of each operating system to insure they are protected against all known threats. In the past when a major virus appeared, it sometimes resulted in a surge in earnings for Microsoft because of the wave of upgrades.
Apple quickly issued updates to all their current operating systems and they will be automatic. The Safari web browser requires an update that has not yet been pushed to all devices. Apple said that update would be available next week.
Intel said it has issued software updates for up to 90% of its products released in the last 5 years and should have all covered by the end of next week. Nobody knows how far back in Intel's product cycle they will go to issue updates for their processors. They may depend on operating system updates from Microsoft to cover processors older than five years.
Google said patches for the Chrome browser would be available on January 23rd.
Microsoft Azure, Amazon Web services and Google Cloud have updated most of their servers and the rest should be completed this weekend.
The Intel CEO, Brian Krzanich, is taking a lot of heat. He sold $39 million in stock and options in late November, several months after Meltdown and Specter were discovered but prior to being announced to the public. When a flaw is discovered in some computer software or component, the manufacturers are notified first and the flaw is kept secret until they have a patch for the problem. In this case, Intel was notified months ago and the CEO sold all but 250,000 shares of his stock for roughly $39 million. Officers are required to maintain shares and his contract calls for 250,000 as a minimum. Some analysts claim his sale was prearranged but knowing for months there was a flaw that could tank the stock makes the sales subject to increased scrutiny.
There are some ambulance chasing lawyers already trolling for cases against Intel for releasing the flawed processors. Since there are no records of anyone actually being harmed by either flaw, it could be tough to make a case.
While on the subject of processors and chips, Goldman Sachs said Nvidia (NVDA) was still the best chip stock for 2018. Goldman reiterated a buy rating and $228 price target saying the company would continue to beat earnings estimates as demand for their products increases. Goldman said Nvidia will launch new graphics cards based on their new Volta chip and demand would be high. The bank said their earnings estimates for Nvidia is $6 for the next fiscal year, where the Wall Street consensus is $4.53. Goldman said Nvidia continue to enjoy first mover advantage and the sheer size of their market will lead to positive EPS revisions.
With the annual CES electronics show next week, you can bet Nvidia will get another boost. Intel will be spending all its efforts defusing the Meltdown and Specter headlines while Nvidia will be promoting their next dozen or so products. Intel CEO Krzanich will give the keynote address this year but Nvidia CEO Jensen Huang will take over the Sunday night preshow address and will focus on their progress in virtual and augmented reality, autonomous cars and next generation PCs.
AMD could get a boost if Intel previews their new i7 module that incorporates an AMD Raedon GPU.
Intel will try to prove it is still relevant and Nvidia will try to build on its reputation for being on the leading edge of chip technology. I would love to be in that Nvidia presentation.
Sears Holdings (SHLD) announced they were closing another 103 stores. That will be 64 Kmart stores and 39 Sears stores. Liquidation sales will begin next Friday. Sears announced the closing of 250 stores in 2017 and 216 in 2016. The actual closings will be in March and April. As of the end of October, there were 595 Sears stores and 510 Kmart stores remaining. Shares fell to a new closing low.
Constellation Brands (STZ) reported earnings of $2.00 compared to estimates for $1.89. Revenue of $1.8 billion missed estimates for $1.87 billion. In the year ago quarter they posted earnings of $1.96 and $1.81 billion in revenue. For the quarter beer sales rose 8.0% but wine and spirits sales fell -10.3%. While wine sales were weak, the majority of that decline came from divesting their Canadian wine business in December 2016. The company guided for full year earnings of $8.40-$8.50 and consensus estimates were $8.43. Recently the company announced a $3 billion buyback against their market cap of $38 billion. They also invested $190 million into a 10% stake in marijuana company Canopy Growth. Shares fell $6 on the earnings news.
Excluding charges, Cal-Maine Foods (CALM) reported earnings of 55 cents that missed estimates for 68 cents. Revenue rose 42% to $361.2 million but still missed estimates for $364 million. The company was impacted by a charge of $52.8 million or $1.09 per share for an antitrust settlement. The CEO said the outlook was good with a strong egg market and improved pricing. Shares declined $3 on the news.
Tyson Foods (TSN) was upgraded to overweight at Piper Jaffray with a price target of $94. The analyst said "management was focused on growing more value added products to expand margins and reduce volatility." Shares had been trending slightly lower in December and this could reenergize them.
Netflix (NFLX) shares rallied to a new high after David Letterman announced the lineup of guests on his new talk show "My Next Guest Needs no Introduction." I am not sure what order but President Obama, George Clooney, Malala Yousafzai, Tina Fey, Howard Stern and Jay-Z. I am guessing Letterman's recent gig as a department store Santa left him wanting to do something more. (joke) Netflix shares had been posting gains on the Apple acquisition speculation but they surged higher on the idea that Letterman's show would be another hit for the streaming company.
Diplomat Pharmacy (DPLO) reaffirmed earnings guidance saying they expect to report $4.5 billion in revenue and $102 million in EBITDA. For 2018, the company guided for $5.3-$5.6 billion and EBITDA of $164-$170 million. That is a 60% increase from year ago levels. Diplomat is the largest independent provider of specialty pharmacy services. Shares rallied 11% on the news.
USG Corporation (USG) surged 7% to a new high after Barclays upgraded them from neutral to overweight and RW Baird upgraded from neutral to outperform. The company is experiencing a boom in demand for building products as a result of the hurricanes in Texas, Florida and Puerto Rico.
Crude oil prices rallied for the week despite fading slightly on Friday. Crude closed at $61.93 on Wednesday and held at that level for a short time. Friday's minor 42-cent decline was likely profit taking. Oil inventories declined -7.4 million barrels for the week ended Dec 29th. Inventories have declined -33 million barrels over the last six weeks as refiners tried to process as much oil as possible before the property tax deadline on 12/31. Refinery utilization rose to 96.7% and the high for the year as they pushed as many refined products as possible out of inventory and into the pipelines.
Inventories could begin to rise next week for the week ended the 5th, but definitely the next week and for the next three months. This could put pressure on prices along with the restart of the 450,000 bpd Forties pipeline in the North Sea and the 95,000 bpd pipeline in Libya.
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Euphoria is breaking out all over. The S&P surged through resistance to gain a whopping 69 points for the week or 2.6%. At the risk of seeming pessimistic, that is a lot of points on top of +256 points previously gained since the August lows. I am happy as a litter of puppies about the gains but where are they going to stop?
The S&P has been pausing routinely for consolidation on the way up but there has been very little retracement. I am sure we would all like the market to do this the rest of the year, with minor pauses rather than big volatility events every couple of months. Those pauses have apparently been enough to allow the index to move higher but we all know it will not last.
As I said earlier, the first roadblock would be the potential for a government shutdown on the 19th unless they kick the can farther down the road. The second hurdle would be the passage of Q4 earnings. There could be some profit taking after all the post tax cut guidance is priced into the market. Fortunately, that is six weeks from now. We could be a lot higher by then.
Lastly, the higher we go before there is a material decline, the larger that decline could be. Just bear that in mind over the coming weeks.
For now, investors are content with chasing the new highs in anticipation of massively improved guidance.
The Dow exploded past 25,000 at Thursday's open without even a minor pause until it hit 25,100. The index moved sideways the rest of the day to end at 25,075. Friday's gap higher never looked back as shorts raced to cover and investors chased prices higher as euphoria took over.
Analysts on stock TV were pounding the table on the market and targets were being raised by somebody almost daily.
Boeing has been a major contributor. Their gains on Friday were on news they may be close to a deal to acquire a stake in Brazil's Embraer (ERJ). Reportedly, they agreed in principal on terms that would value Embraer at $28 per share. ERJ was trading below $20 when the news of talks first broke on Dec 21st. The news of a verbal agreement broke Friday and Boeing spiked $12 to add 84 Dow points. Boeing is acquiring a stake in Embraer to offset the new Airbus stake in Bombardier. Boeing is up $114 since early July and has added 775 points to the Dow.
Obviously, the Boeing gains are not going to continue on a daily basis but the Dow has been fortunate that a handful of stocks have outperformed every day to continue pushing the index higher. When these high fliers finally rest, they will have the opposite impact on the index.
The Nasdaq gained 233 points for the week and blew through the 7,000 level and then through the 7,100 level with equal ease. The big cap stocks are suddenly on fire with many of them at new highs. This is a dramatic change from the lackluster performance for the last two weeks of December where most were testing two-week lows. The tide turned and suddenly they are back in favor.
The Nasdaq has been taking periodic rests every 2-3 weeks so it is actually better off for a longer term rally than the Dow and S&P. The decline in late December was the smallest of the last six retracements.
The Russell 2000 remains the laggard. The index is making new highs but with far less enthusiasm. The resistance at 1,550 has broken but there may still be some gravimetric pull that is holding the index back. If the small caps would catch fire, the broader market rally could have further room to run.
It is inevitable that this suddenly vertical rally is going to pause. I still believe that any pullback or pause will be minor because of all the positive points I wrote about earlier. The bulls are in control and sellers are nowhere to be found. They have been flattened by the stampede.
Personally, I would not continue to chase the new highs. I would look for stocks that have not blown out to new highs. Contrary to current sentiment, there is no rush to put all your money into the market. Look for a pause as a buying opportunity.
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