The markets are off to the best start in 31 years and the opening gains in 1987.
January 1987 saw the S&P gain 13% with the gain over the first three months of the year a 25.4%. It was an outstanding start to the New Year and investors were giddy with their success.
So far in 2018, the Dow it up 7.7%, Nasdaq 9.8% and S&P +7.4%. Those numbers pale in comparison to 1987 but it has still been a good year and it is only four weeks old.
Unfortunately, 1987 is not remembered for the big gains in the first quarter but for the big declines later in the year. After posting a 39.7% gain for the first 9 months, the S&P fell -34% in only 11 days in October 1987. I am not predicting that 2018 will mirror 1987 but euphoric rallies tend to end badly. As you can see in the chart there was no material warning that the bottom was going to fall out. The index was trading within a few points of its highs and 18 days later, it had given back nearly all the gains for the year.
I do not want to be that voice in the wilderness always saying the sky is falling. I am far from bearish. However, as a market analyst for the last 20+ years, I have watched hundreds of cycles where the market has gone up sharply and then retraced those gains. I think analysts get trapped in this cycle fetish. We are so used to watching the repetitive cycle that when a market post gains like we have seen for the last several months, it just seems obvious that profit taking will appear. When days and weeks pass and the upward velocity continues to increase, it only intensifies our natural reaction to try and apply a cycle to it.
Over the last month, I have pointed to early to mid February as a potential rocky period. I have said repeatedly that I expect the market to continue rising through next week. My opinion has not changed.
I got a big kick out of a reader last week. I said something in last weekend's market commentary about the potential for a rocky February and he called me a "leftist liberal fear mongering democrat." I have been called worse but I believe long time readers know that is not my mindset. Another reader said "the Trump rally will be at 30,000 by September. The future is so bright I gotta wear shades!" I sure hope he is right.
Everyone has an opinion, right or wrong, and that is what makes a market. I simply try to keep readers focused on the fact that nothing goes up forever without a pause.
Friday's economic news was weaker than expected. The first look at the Q4 GDP showed 2.55% growth when the consensus was for 3.0% growth. This is the first release and it will be updated twice over the next two months. This was down from the 3.16% growth in Q3 and 3.06% in Q2. Inventory accumulation removed -0.67% and net exports removed -1.13%. Consumption added 2.58%, fixed investment +1.27% and government +0.50%.
We know consumer spending is going to spike higher in Q1 now that hundreds of companies have announced bonuses as a result of the tax reform and consumers will be getting an average of about $100 more in their checks each month from lower taxes.
Hurricanes depressed growth early in Q4 but then accelerated growth late in the quarter as the rebuilding increased in intensity. This will continue in Q1.
The Atlanta Fed real time GDPNow forecast was holding right at 3.4% growth for Q4 on the last update. This suggests the BEA GDP above could be revised higher over the next two months.
The Durable Goods report for December showed a 2.9% rise in orders compared to consensus estimates for 0.9% and the 1.3% reading in the prior report. The gain was powered by nondefense aircraft at +15.9% and defense at +19.5%. Backorders rose +0.6%. New durable goods orders are up 11.5% over the same period in 2017. Analysts are worried that the ultra cold weather in January could have slowed manufacturing with everyone huddled in the common areas to keep warm.
Next week is very busy. This is a payroll week, FOMC meeting, ISM Manufacturing and State of the Union speech. There are a lot of reports that will be competing for headlines along with the very busy earnings calendar.
This is big cap tech week for earnings plus there are 125 S&P companies including ten Dow components. Google, Amazon, Apple and Alibaba will make Thursday the peak day for techs but Qualcomm, Facebook, PayPal and Microsoft will precede them on Wednesday. Conoco, Exxon and Chevron plus about a dozen other energy companies will also report.
As of Friday 24% of S&P companies have reported and 76% have beaten analyst estimates with 81% beating on revenue. The blended growth rate for earnings has risen from 11.7% to 12.0% not including the noncash charges related to tax reform. The blended estimate for revenue growth is 7.0% and rising. According to FactSet, earnings are expected to grow by double digits for the rest of 2018. That is a powerful force for future market expectations. The forward 12-month PE is 18.4, which is above the 5-year and 10-year averages.
The big earnings winner on Friday was AbbVie (ABBV). The company reported adjusted earnings of $1.48 compared to estimates for $1.44. Revenue of $7.74 billion beat estimates for $7.57 billion. They guided for full year earnings in the range of $7.33-$7.43 per share, up from $6.37-$6.57. The FactSet consensus estimate was $6.66. The company said it planned to invest $2.5 billion in US capital projects and a possible expansion to its US facilities. Sales of Humira, Imbruvica, Lupron, Creon, Synagis, Kaletra, Sevoflurane and Duodopa all came in above expectations. Shares spiked $15 on the news.
Honeywell (HON) reported earnings of $1.85 that narrowly beat estimates for $1.84. Revenue of $10.84 billion beat estimates for $10.77 billion. The company guided for full year earnings of $7.75-$8.00 per share on revenue of $41.88-$42.68 billion. That was an increase from $7.55-$7.80. They plan to repatriate $7 of the $10 billion in overseas cash and use it to fund their M&A activities, a competitive dividend and share buybacks.
Lear Corp (LEA) reported record earnings of $4.38 that beat estimates for $4.25. Record revenue of $5.36 billion beat estimates for $5.27 billion. They are projecting 17.4 million in vehicles sales in North America and 23.4 million in Europe and Africa plus 26.5 million vehicles in China. Free cash flow is expected to be more than $1.2 billion. They also announced the acquisition of EXO Technologies. They are a leading developer of differentiated GPS technology providing high-accuracy positioning solutions without the need for terrestrial base-station networks to support autonomous and connected vehicle applications. Shares rallied $6 on the news.
Colgate (CL) reported earnings of 75 cents that matched analyst estimates. Revenue rose 4.5% to $3.9 billion but missed estimates for $3.92 billion. Advertising spending rose 24% to $369 million and they plan to increase spending further in 2018. They guided to mid single digit sales growth in 2018 despite lowering sales prices as much as 2% to drive sales volume. Colgate sales are seen as stagnating in a positive global market and shares declined sharply on the report.
Wynn Resorts (WYNN) shares fell more than 10% after founder and Chairman Steve Wynn was accused of sexual misconduct by an article in the WSJ. The paper said it talked to more than 150 current and former employees and reported details on numerous events. The article alleges Wynn had a pattern of sexual harassment against employees who were paid to perform sexual favors while they feared losing their job. One manicurist settled for $7.5 million after Wynn reportedly forced her to have sex with him in his office even though she repeatedly rebuffed his advances and told him she was married. Immediately after the event, she filed a formal complaint and eventually settled out of court.
The problem mushroomed into a much bigger deal than just paying $1,000 per hour for sexual massages by the hotel's spa employees. The Nevada and Massachusetts gaming boards have opened an investigation saying the accusations would violate the "moral turpitude" clauses in their license requirements and could result in a revocation of their gaming licenses. If these accusations are true, Wynn could be ejected from his company. The board has already opened an investigation. He lost $250 million on Friday as the stock fell more than 10% on 12 times normal volume. The company lost more than $2 billion in market cap.
This kind of an event is a good lesson on why you should always have stop losses.
Boeing (BA) miraculously posted a fractional gain despite an unexpected ruling that Bombardier did not have to face a 300% duty on their CSeries 110-130 seat planes sold in the US. The US International Trade Commission had been expected to rule in favor of Boeing after the company had complained that Bombardier was selling planes in the US under cost at "absurdly low prices." Boeing said Bombardier dumped 75 of the planes in a sale to Delta. The ruling was 4 to zero on the ITC panel. Boeing can still appeal the decision and probably will just to keep the cloud of uncertainty over the sale of Bombardier planes in the US as long as possible. The ITC said Boeing was not harmed by the discounted planes since Boeing does not offer an exact competitor in that class. Boeing is trying to form a partnership with Embraer to offer a competitive plane to the CSeries.
Kroger generated a lot of news last week. Alibaba (BABA) is reportedly in talks with Kroger about an alliance. Kroger officials went to China for the discussions. Kroger has a market cap of $27 billion compared to Alibaba's at $508 billion. For Kroger that would be the equivalent of the lamb walking into the lion's den to talk about dinner. Kroger may be looking for a technology partner to combat the Amazon/Whole Foods acquisition. You know Amazon is going to expand the Whole Foods footprint and could do it through acquisitions. Kroger already opened its 1,000th ClickList location in December and they have a Scan, Bag, Go service in 400 locations.
Kroger has also been in acquisition discussions with online wholesaler Boxed and online retailer Overstock.com. Kroger recently announced a restructuring plan called Restock Kroger where they are going to "redefine" grocery shopping and expand the customer experience. Recent rumors claim Kroger's bid for Boxed.com may have come up short and Amazon could also be in the bidding.
One retail consultant wrote last summer that Alibaba should buy Kroger as a way to enter the US retail market and extend and complement their global retail ecosystem. He wrote that acquisition would be Kryptonite to Amazon Whole Foods and Walmart/Jet.com.
On Friday, we learned that Casey's General Stores (CASY) has reportedly submitted a bid for Kroger's convenience store chains valued at more than $2 billion. Casey's could be looking for a poison pill to push away activist investor JCP Investment Management, which is trying to get Casey to put itself up for a sale. Kroger announced last year they wanted to sell their 780 convenience stored and Goldman Sachs is shopping the assets. The stores go by multiple names like Kwik Shop, Loaf 'N Jug, Turkey Hill Minit Markets, Tom Thumb, Quick Stop, etc. They have accumulated these as they acquired the supermarket chains associated with them over the years.
Kroger is a massive retailer with 2,790 retail food stores in 35 states, 2,266 pharmacies, 1,480 supermarket fuel centers, 785 convenience stores, 306 jewelry stores, 219 retail health clinics and 38 food production plants.
Lowe's Companies (LOW) announced a new $5 billion stock buyback program in addition to the $2.1 billion remaining on their existing program. No date was given for the program, which means it could be a public relations effort rather than a plan to give back to shareholders and lift the stock price. Open-ended plans tend to never be completed. Those companies that get the most bang for their bucks are the ones that put a short fuse on the program as in 3-6 months. Their stock prices tend to rise sharply. However, if Lowe's waits until a market correction appears and then goes all in on the dip, it could keep their shares supported and provide a quicker rebound. There are pros and cons for both methods of buying back stock. Lowe's shares are at historic highs so waiting for a dip would be preferable and a wiser use of capital.
Twitter (TWTR) shares got a boost after noted short seller Andrew Left of Citron Research tweeted he owned Twitter shares and the stock was going to $35. He said engagement levels were rising and Twitter dominates the social media space for news. He said Twitter was a better acquisition target than SNAP and a company like Tencent might be interested in taking a huge position in the US social media market.
Barron's said Twitter could be acquired by Salesforce.com. A CFRA analyst contradicted that scenario saying while there were multiple merger rumors, the bigger news was the company working on a SnapChat clone for easier media sharing in addition to texts and tags.
Overall, there have been numerous positive mentions about Twitter in the last several weeks and shares are rising.
Crude prices closed at $66.24 on Friday and a three-year high. The crashing dollar was responsible for most of the movement over the last week. US producers added 12 oilrigs last week to 759 and the largest weekly gain since March. Gas rigs declined by 1 to 188. Large speculators raised their net long positions in WTI by 7,612 contracts to a new record high at 549,602. The CME said speculators raised their net long positions in Brent crude by 13,912 to a new record of 584,707. That equates to 584.7 million barrels of oil.
With everyone 100% long heading into a normally weak two-month period for crude prices, there could be a monster volatility event in our near future.
The major indexes closed at new highs again but the AAII investor sentiment survey took a major turn lower. This survey ends on Wednesday and the Dow was flat on Tuesday and dipped on Wednesday. The Nasdaq imploded on Wednesday with a major -110 point reversal from the intraday highs. Investors immediately fled the bullish camp thinking the rally was over. Surprise, surprise! The Dow, S&P and Nasdaq all rebounded to close at new highs.
Schwab posted this chart from Bloomberg showing the relative performance of years following years with exceptionally low volatility. 2017 was tied with 1995 for low volatility with the biggest S&P decline at 3.1% for the entire 12 months. I thought the chart was interesting but I do not think it is relative in our current environment. The factors driving the market today, tax reform, rising earnings, low interest rates and strong global economy are likely to continue driving the market the rest of the year. There will be weak patches but we should end the year higher.
Schwab's Liz Ann Sonders tweeted on Friday that the market was the most overbought since 1904. (not a typo).
Schwab also warned that the Citibank Economic Surprise Index was rolling over. This index measures the number of economic reports that are moving higher versus the number of reports moving lower. In theory, this is a leading indicator for a weakening economy. Personally, I believe the economic conditions got ahead of themselves in the optimism department and this weakening is more of a reversion to the norm. For instance, the consumer sentiment indicators have faded over the last two months but are still near record highs. This will be something to continue watching but the index is still well above zero.
Bank of America reported another week of record inflows into equity funds of $33.2 billion. By comparison, a total of $278 billion flowed into equities for all of 2017. Last week equated to 11.9% of 2017 money flows. YTD has seen $77 billion flow into equity funds. At the same time, they warned a significant pullback in "sky-high" markets in the next couple of months was "very likely."
BAML private client equity exposure is rising at the fastest pace in 10 years and cash allocation is at record lows. The BAML "Bull & Bear" gauge has given a sell signal at 7.9 and just under the 8.0 level where BAML recommends selling. The indicator has given 11 sell signals since it began in 2002 and has been 100% accurate all 11 times. The average peak to trough drops in the following 3 months after a sell signal has been -12%. "A tactical S&P-500 pullback to 2,686 (-6%) in Feb/Mar is now very likely" according to BAML. They also warned that a sudden reversal in the dollar's decline could spark a sharp correction. In the note they reminded that the 1987 market crash was triggered by a FX spat between the US and Europe.
Currently the S&P is closing in on 2,900. Three or four more days like Friday and it would be nearing 3,000. There was a blowout on Monday and another one on Friday and the S&P gained 62.5 points or 2.2% for the week. It is now up 7.5% for the year. It should be evident on the chart that the advances are out of character compared to the prior trend. We know the market can continue higher for weeks to come until buyers run out of money or conviction or both. The markets always revert to the mean. Sometimes it just takes a little longer than others for that to happen.
The Dow milestones are flying by faster than mile markets on an interstate highway. The time between 25,000 and 26,000 was only 9 trading days or 13 calendar days. That was a record for the shortest time. The index is already threatening to hit 27,000 next week. Obviously the higher the market goes the faster the milestones will be hit because the percentage difference between the points grows smaller every day. The Dow had to rise 100% to go from 1,000 to 2,000 or 10% from 10,000 to 11,000 but only 4% to go from 25,000 to 26,000. Multiple analysts have said we could see 30,000 before the year is out. The Dow is up 8,729 points or 48.8% since the election.
The Dow components were solidly positive on Friday with the exception of Goldman and Caterpillar. CAT reported earnings on Thursday and is still fighting post earnings volatility. To its credit, the stock is only down about $1.50 from the pre earnings close and that was after a monster gain of 75 points since April.
The Dow continues to accelerate higher and the 26,000 level is now initial support. The index is now 12% above its 100-day average.
The Dow Transports lost -1.6% for the week. This is a sentiment drag on the Dow Industrials but you could not tell it from the Dow's gains.
The Nasdaq had a huge bout of profit taking on Tue/Wed but shook it off and charged higher to close over 7,500 only 4 days after closing over 7,400. The big cap tech stocks are suddenly on fire again and the big group of tech earnings are not until next week. It will be the following week where we could see some weakness.
The Russell was the under achiever last week with a +0.6% gain compared to the 2.1% on the Dow and 2.8% on the Nasdaq 100. The index is holding over support at 1,600 but just under resistance at 1,610. The index has only had three days of strong gains in January.
The trend is your friend, until it ends. I am sticking with my forecast of continued gains next week but a potential rough spot in February as some of the current excesses are removed.
The way the immigration fight is shaping up in Washington the odds are good we are going to get another government shutdown. Like we saw last week, the negative impact to the market was weak and the post shutdown rebound was strong. I would expect that same cycle if another shutdown appears.
The State of the Union speech on Tuesday could be a wild card. We never know what will be said and how it will impact the markets. Comments over trade wars, dollar weakness, treasuries, interest rates, tariffs, North Korea, Russian investigation, etc, could cause ripples in the pond.
I told a couple readers I would try and have the graphic on all the analyst targets done this weekend but it remains incomplete. Many analysts seem to be waffling on picking a target this year. Most claim they want to see how the guidance in Q4 earnings plays out before picking a number and I understand that. I will try to fill in some blanks this week and I will publish what I have next weekend.
Enter passively and exit aggressively!
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