The Senate failed to pass the budget resolution on Friday and the government is in shutdown mode.
The market did not seem to care if the government was going to shutdown on Friday at midnight. We have been here before when President Obama weaponized the 2013 shutdown by closing everything possible to inflict pain on voters and have them direct their ire toward the republicans. However, the administration message all day on Friday was for a less stressful event. The Trump administration planed to keep everything open and running as much as possible claiming there is no need for America to stop running just because politicians are in disagreement.
After that message made headlines around lunchtime on Friday, the major indexes began to rebound and the Nasdaq, S&P and Russell all closed at record highs. The Russell was especially bullish with a 1.3% rally. The index rebounded sharply after a minor dip at the open and never looked back. The Dow spent most of the day in negative territory and did not begin rebounding until 2:00.
While the impact of a shutdown on the market is normally minimal, the rebound is normally strong. Kensho reported that the average S&P decline is -0.3% although some have been substantially more. The average rebound after the shutdown is +2.1% on the S&P. Today that would be about 60 points. In the 16-day shutdown in 2013, the S&P declined from 1,682 to 1,656 or -1.5%. The rebound ran from Oct 10th through December 31st where the S&P closed at 1,848 for an 11.6% post shutdown gain. This suggests that any decline next week should be bought. There is no guarantee the market will continue significantly higher but it should continue for the next couple of weeks until after the big cap tech earnings have been released.
The market did not get any help from the economic reports on Friday. The Consumer Sentiment for January declined for the third consecutive month falling from 95.9 to 94.4. The peak was a multiyear high at 100.7 in October. The present conditions component declined from 113.8 to 109.2 and the lowest level since November 2016. The expectations component rose slightly from 84.3 to 84.8. Of the respondents, 34% mentioned the tax reform unprompted and 70% said they expected a positive impact to incomes. Some 56%, up +3%, expect the economy to do well over the next 12 months.
The industry GDP rose from 2.74% in Q2 to 3.28% in Q3. Private industries added 3.3% while the government only accounted for 0.07%. Because this is a lagging report, it was ignored. The actual GDP for the entire US will be out next week and a 3% growth number will be the third consecutive quarter of GDP growth over 3% and this has not happened since early 2005.
The calendar for next week has a lot of reports but none are expected to be market moving. The new and existing home sales will continue to tell us that business is good. The Chicago, Richmond and Kansas reports should be in line with estimates and show continued expansion. The GDP is likely to get the most press if it is over 3% growth.
The earnings calendar will be more important to the market than economics. With eight Dow components reporting we could see additional Dow volatility. Thursday has CAT and MMM before the open and that could generate a downdraft if they do not post outstanding results. Intel reports after the close and there are worries they could guide lower because of the Meltdown and Specter hacks that still require active patching both to old chips/software and design changes to new processors.
As of Friday, 11% of the S&P has reported with 68% beating on earnings and 85% beating on revenue. However, the blended earnings growth for Q4 declined sharply from 10.8% to -0.2%. The reason was the big charges taken in the financial sector related to the new tax law. The financial sector alone accounted for a drop in S&P earnings of -$29.2 billion. This is the only sector that posted earnings declines last week.
This is going to be a problem in the future. As a result of the tax changes the earnings reports are going to be messy. These are all non-cash charges and gains but they will make comparisons to prior quarters nearly impossible. Each individual stock will rise and fall on its own merits based on the adjusted earnings numbers but the official GAAP earnings are going to be a witch's brew of charges.
Bank of America reported that $58 billion in cash has flowed into the market in the four weeks ended on Wednesday. That is the highest pace ever since records have been kept. That has powered the Dow to a 5.5% gain for the year, Nasdaq 6.7%, S&P 5.1% and Russell 4.0%. Equity ETFs saw inflows of $38.2 billion with mutual funds garnering $5.6 billion.
Last week $23.9 billion flowed into equities and that was the 7th largest inflow ever. Unfortunately, those money flows are not going to continue forever.
One challenge is the sudden rebound in yields on treasuries. The yield on the ten-year closed at 2.637% and the highest level since June 2014. At some point, investors are going to decide the equity market is grossly over extended and the yield on a treasury would be a good place to park their cash until the equity market corrects.
Conversely, Bill Gross proclaimed the end of the multi-decade bull market in treasuries and said a new bear market had begun. With bonds/treasuries suddenly selling off, those investors are looking at equities as a better opportunity.
I know those two scenarios contradict each other but there is a point where treasuries will become attractive again. Analysts believe that is the 3% yield level. They do not see yields spiking much over 3% with central banks still overly accommodative. That means yields will probably peak around the 2013 highs at 3.0% and hold there until the Fed executes a few more rate hikes this year.
In the short term, funds are coming out of treasuries and into equities. That is helping prevent any material market declines.
Monday will be a record 395 trading days without 5% drop on the S&P. That is the longest streak in history with records dating back to 1929 according to Goldman Sachs. The current economic expansion is nine years old and the second longest on record. After multiple quarters of earnings declines, we have seen six consecutive quarters of earnings growth. Despite all this bullishness, the median analyst price target for year-end is only 2,855.
The Investors Intelligence poll of professional newsletter editors rose to 66.7% bullish versus 12.7% bearish. That is the widest spread since April 1986.
The AAII sentiment survey of individual investors saw a rebound in bullish sentiment to 54.1% while bearish sentiment declined to 21.4%. This was still below the extreme readings of 59.8% and 15.6% from two weeks ago. That was the most bullish since December 2010 and the most bearish since November 2014.
Individual investor sentiment is still rising but at a slower pace after the multiple days of whiplash volatility over the last week. Some of the "over extended" comments by analysts may be taking hold.
The dollar is continuing to decline and that remains positive for commodities. Gold rose again and is likely headed back to the $1,365 resistance from mid 2016.
In stock news, Facebook (FB) was making waves again saying they were going to prioritize "trustworthy news" based on user surveys. Users rather than moderators, experts or Facebook executives would determine which of more than two million news sources had accurate news stories. Zuckerberg said the change would eventually shrink the amount of news on Facebook by 20% to about 4% of all content. As users answer survey questions about what they read, the system would prioritize the most trusted sources and reduce exposure to those with the worst reviews.
I am sure you can see where this is headed. Trump's base will be clicking "fake news" on every mainstream media site and democrats will be giving Fox news negative reviews. It will turn into the website with the least negative reviews winning the rating race rather than the website with the most positive reviews.
Since Facebook has already been found guilty multiple times of suppressing conservative news and promoting liberal views, it is questionable at best on how this new system will work out. This is their third plan over the last year on trying to deal with fake news such as the Russian spamming that was heavy during the election. Newscorp pledged to look for "any signs that the weighting of news sites is politically motivated." Good luck with that.
Wynn Resorts Ltd (WYNN) said a group of people, including employees at the Wynn Macau had stolen $6 million in chips. One dealer and several accomplices were arrested. Wynn said they were still unclear on exactly how the group got the chips out of the casino. One theory is that the group accumulated the chips in a VIP room and just stuffed them into a bag and walked out with them. This is not exactly an Ocean's Eleven type of operation but more than likely a simple crime of opportunity. They may have distracted casino officials in order to get their loot out the door but the cameras do not lie. Once the chips went missing, a review of the security footage provided the suspects.
Wynn shares did not react negatively to the news. Shares are up $17 over the last week to close at a new high. Jefferies added a boost on Friday when they initiated coverage with a buy rating. Earnings will be released before the open on Jan 22nd. Puts anyone?
Protection One (ADT) went public on Friday and nobody protected their stock. They tried to price it between $17-$19 but at the last minute changed it to $14. The stock opened at $12.65 and dipped to $12 just before the close. The company raised $1.47 billion with 105 million shares. PE firm Apollo Global Management retained 84.87% of the company. ADT has 7.2 million customers and handles about 15 million alarms a year. They have about 30% share in this increasingly competitive sector. Revenue over the last nine months was $3.21 billion, up 69% with more than 90% coming from monthly monitoring subscriptions.
The challenge for ADT is their enormous debt load and the surge in Ring Central, Nest Security, Stanley Convergent Security, Vivint, Tyco, Arlo security cameras and dozens of other lesser-known competitors. The sector is booming with the do it yourself home security systems.
Shares of Chipotle Mexican Grill (CMG) gained $6 on Friday after Raymond James upgraded them from sell to hold. That is hardly a strong upgrade and the analysts said they no longer see any downside risks to 2018 estimates. Obviously that is different than saying the outlook is good. They warned that CMG was "not out of the woods" yet because of poor traffic flows in Q4.
At the same time Cowen reiterated an underperform saying Facebook check-ins suggested traffic trends were still falling. The Cowen analyst said comps for Q4 would be flat and could lead to disappointing 2018 guidance.
Jefferies upgraded Kohl's (KSS) to a buy with a $100 price target. The analyst said Kohl's is sleeping with the enemy (AMZN). In October, the retailer began selling Amazon's smart home products and accepting returns on Amazon products. The pilot program has been a success and the analyst expects it to roll out to all of the Kohl's stores. The retailer has also been ramping up its "ship from store" capability that allows them to sell to people that are not close enough to drop by but still in the retailer's area. Kohl's is also planning on adding groceries to its larger stores. The company is shrinking its retail space and reducing the number of skus they are carrying in inventory. This leaves them with 10-15,000 sqft of unused space and by partnering with a grocery retailer, they can benefit from the daily traffic generated by the grocer.
McCormick & Company (MKC) was downgraded by Deutsche Bank from hold to sell with the price target cut from $103 to $98. There does not appear to be a lot of analyst confidence in that call with only a $5 spread. However, the stock closed at $103 on Thursday and hit $98.57 on Friday. Time to buy now? I would probably wait for a dip to $94.
Crude prices fell $1 for the week despite an unexpected decline in inventories. Inventories should have risen last week but instead declined -6.9 million barrels. Refinery utilization fell sharply from 95.4% to 93%. With the extremely cold weather in most of the nation in January, gasoline and diesel demand is falling. This will add to inventories in the weeks ahead. Active rigs declined by -3 after a +15 gain the prior week. That was also unexpected given the oil prices near $65 and at $70 for Brent.
The S&P posted a decent gain of 12 points to close at a new high and become even further over extended. Markets can continue to maintain directional momentum far longer than anyone expects. The government shutdown could be a drag next week but I would expect another rebound once the shutdown is over. It is not that the event will impact the economy in a material way but the post shutdown rebound is just a relief rally that nothing serious happened.
The uptrend resistance is around 2,750 with a potential pause point at 2,774.
The Dow is starting to run into some trouble. With eight Dow components reporting next week there will be volatility. Whether it will impact direction is unknown. We do know that by Feb 2nd, more than two-thirds of the Dow will have reported and post earnings depression will be a factor. Even if a company spikes higher post earnings they tend to fade within a week. That suggests the Dow could peak over the next ten trading days.
Some of the big gainers are already starting to slow and once CAT, MMM and UTX report next week, they could add extra drag. Boeing does not report until the 31st.
The Nasdaq continues to make new highs despite choppy performance by the big cap tech stocks. Only half were positive on Friday but other than Priceline and Broadcom the rest were only fractionally negative. Google was leading the pack with new highs and Nvidia was dragging the chip sector higher with its new high.
The Nasdaq has a 13-day rally going and that is the second longest streak without profit taking since April. The 2-3 week cycle should be coming to an end sometime in early February.
Support is back at 7,200 followed by 7,110.
The Russell 2000 was a shock on Friday with a 1.3% rally and a new high close. Uptrend resistance at 1,600 is just ahead and it was solid on the last two attempts. The small caps should be in rally mode but they have only been able to post three solid single day gains since mid December. I wish Friday was the start of a new leg higher but the government shutdown could impact the Russell more than the big cap indexes.
As of late Saturday, the government shutdown appears likely to extend into next week. As I have written several times over the last two weeks, the two sides are growing farther apart rather than closer together. Now that the shutdown has occurred, they have hardened their positions in an effort not to appear weak and conciliatory. Both sides have solidified their positions on illegal immigration with the democrats claiming they will not approve funding for anything until the 850,000 illegal DACA immigrants have been given some sort of amnesty. The republicans, from the White House on down have said they will not negotiate on DACA or any immigration points while the democrats are holding 330 million Americans hostage with their immigration demands. Democratic senators are blocking all attempts to bring new votes to the floor. The senate will reconvene again on Sunday but the outlook is grim.
The house was supposed to be out of town this week. In the calendar below the yellow is when both the house and senate are in session. The blue is when only the senate is in session. Many house members had already left for their home state when the senate vote had stalled. The few members remaining have already prepared for an accelerated voting process if the senate were to pass a funding bill.
The farther this shutdown progresses, the more heated it will become. That means the market is more likely to be impacted by the events. However, the instant there is daylight at the end of the process, the market should move higher in a relief rally. I would recommend buying any dip for a short-term bounce.
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