The markets opened negative and hit their lows about 10:30 on only a minor increase in volume.

Market Statistics

In a big market selloff, you want to see capitulation by existing holders. That normally means a large advance to decline imbalance and very high volume. That tells analysts that the dip is meaningful and investors are racing to the exits. Today was not one of those days. An A/D imbalance of 8:1 or even 10:1 normally signals capitulation at either the top or bottom of a regular market cycle. Today declines were 4:1 over advancers. While that is elevated, it is far from a panic. Volume was 8.03 billion shares and only about 10% over levels seen so far in 2018. There was definitely no rush to the exits.

The two day decline of -1.75% was the worst since September 2016. That should give you an idea of how few declines we have had. Actually, there were only two declines of more than 2% in 2017 and this was the first one in 2018.

The blame game started before the market even opened as market commentators tried to assign blame for the negative market. Some blamed the spike in treasury yields to 2.72% on the ten year. Since the yield closed at 2.696% on Monday, I hardly think that was the problem.

Others blamed the end of month portfolio rebalancing by pension fund managers. In theory if you have a balanced portfolio of 60% stocks and 40% bonds, the manager is supposed to rebalance whenever those ratios become unbalanced. With the markets up roughly 8% for the year in January coupled with gains in December, the ratios could have risen to more than 70% equities and 30% bonds. Analysts have been predicting a $16-$20 billion sale of equities at month end to bring the portfolios back into balance. While that theory was making the rounds, there was no material flow into treasuries that would have offset the decline in equities. It may have had an impact and it could be spread over the last three days and the first two days of the month. This may have had some impact on the market but there was no material increase in volume.


The most likely cause of the decline was simply being extremely overbought and the announcement by Amazon, JP Morgan and Berkshire that they were forming a company to provide cheaper healthcare for their 1.1 million employees. That caused the bottom to fall out in the healthcare, pharmacy and drug stocks. The carnage was deep and wide spread. The goal is to reduce healthcare expenses by 20% or more. JP Morgan spent $1.2 billion on healthcare in 2017. If they were able to accomplish this feat, it would be a major blow to nearly every provider of drugs and services.

The group had to go public with their plans because they are starting a hunt for a CEO. The company will be separate and will be "ring fenced" from the parent companies to avoid conflicts of interest. That would also make it potential magnet for dozens if not hundreds of other major corporations also trying to cut expenses. Given Amazon's resources and the razor thin margins they produce, there is a very good chance they will exceed their cost reduction goals and that could upset the entire healthcare industry.

America has the highest drug prices in the world and every drug has to go through multiple hands before it is given to you by the druggist. Some people claim there is 20-40% in costs generated by the various middlemen including distributors, wholesalers, pharmacy benefit managers, etc. With Amazon's clout, they could go direct to the manufactures and force them to bid for the business and discount their own products.

Amazon disrupts. The fear of Amazon disrupting the very profitable drug pipeline business caused massive declines in the various stocks. UnitedHealth (UNH) lost more than $10 to cause a -74 point impact to the Dow.


When markets suddenly decline, stocks that are not a part of that reason, sell off as well. This is the "whoosh" effect. Since most investors do not know minute by minute why the market is moving, only that their charts are falling, they tend to pull the ripcord and bail from their positions to protect their profits. This morning was a whoosh market. As the various reasons being given were discounted by analysts, the market stabilized around 10:30 and traded in a narrow range the rest of the day.



To prove the points above the Volatility Index ($VIX) spiked to 15.40 at the open then faded to trade relatively sideways the rest of the day. There was no panic other than at the open. The spike over 15 was the highest level since August 17th. The VXX futures ETF rose more than $2 on Monday but only 96 cents today. Traders were more concerned about volatility on Monday than today.


The economic news this morning was positive and had no impact on the market decline. The Consumer Confidence for January came in at 125.4, up from 123.1 in December. That is still down from 18-year high of 128.6 in November but still near the high. The present conditions component declined from 156.5 to 155.3 but the expectations component rose from 100.8 to 105.5. That is directly related to the passage of the tax reform package at the end of December and the announcement by more than 100 companies that will give their employees significant bonuses as a result.

Those thinking jobs were plentiful rose from 36.3% to 37.6%. Those respondents thinking of buying a car rose from 13.0% to 13.4%. However, those planning on buying a home declined from 7.4% to 6.0% and appliance buyers from 59.3% to 49.6%. Rising interest rates were blamed on the decline in homebuyers.


The S&P CoreLogic Case Shiller home price indexes showed a 6.4% rise in prices. This was for the November period and the report was ignored as old news.

After the bell, the weekly API crude inventory report showed a build of 3.229 million barrels compared to expectations for a minor build of only 126,000 barrels. Gasoline inventories rose 2.692 million barrels and a decline of -4.1 million barrels of distillates. Prices declined -$1.57 in regular trading and another 10 cents after the bell. The EIA expects US production to top 10.0 million bpd in this week's report or next week at the latest.


The calendar for tomorrow has the FOMC meeting announcement and no rate hike is expected. Currently analysts expect an average of 3.2 rate hikes in 2018. This is Janet Yellen's last Fed meeting and Jerome Powell will take over the Chairmanship after tomorrow.

There is a 94.8% probability of no hike on Wednesday with only a 5.2% chance of a hike. The March meeting has a 72.1% probability.



The consensus estimates for the ADP Employment have risen from 173,000 to 185,000 over the last three days. The estimates for the Nonfarm Payrolls on Friday have risen from 163,000 to 180,000. Unless both reports miss the estimates by a mile there will be no impact on the market. Unemployment is near record lows and everyone expects fluctuation from month to month.


The State of the Union speech tonight could have an impact on the market depending on the content. Everyone is expecting some details on an infrastructure package that could run from $1.0-$1.7 trillion. This would boost materials stocks and is probably why Caterpillar (CAT) was positive in a very weak market today.

The government funding deadline for Feb 8th is going to be a challenge. The partisan divide is actually increasing in hostility and the odds are good we will have another government shutdown that could last longer than the one in mid January. Earnings reports will be declining by that date and the market may not be willing to ignore larger conflict.

The only calendar that means anything to investors for the rest of the week is the earnings calendar. This is big cap tech earnings week and the deck is stacked for the next two days. There are eight additional Dow components reporting over the next three days.


There were some big losers after the earnings reports today. Dow component McDonalds (MCD) fell -3% after reporting good earnings. The company reported earnings of $1.71 that easily beat estimates for $1.59. Revenue of $5.34 billion beat estimates for $5.23 billion but declined from the $6.03 billion in the year ago quarter. Same store sales rose 4.5% in the US and 5.5% globally. The company blamed the sales increase on the McPick 2 menu, beverage value items and "strong consumer response" to the Buttermilk Crispy Tenders and delivery options. The company plans to open 1,000 new stores with 75% funded by affiliates and licensees. The company is also going to spend $2.4 billion to modernize existing locations and provide digital upgrades.

Shares declined -$5 (-3%) on worried the new $1, $2, $3 value menu would reduce sales on other higher priced, higher margin items. Shares closed at a new high on Friday and I am sure they were caught up in the whoosh effect with the Dow crashing -411 points intraday. This is a buying opportunity with a drop to uptrend support.


Dow component Pfizer (PFE) reported earnings of 62 cents that beat estimates for 56 cents. Revenue of $13.7 billion beat estimates for $13.67 billion. They guided for full year revenue of $53.5-$55.5 billion compared to estimates for $53.83 billion. Earnings guidance was $2.90-$3.00 compared to estimates for $2.78. They anticipate buying back $5 billion in stock in 2018 and investing $5 billion in capital projects. They shocked investors with an expected tax rate of 17% and $15 billion in repatriation taxes over the next 8 years. The tax rate was a shock after AbbVie projected a 9% tax rate with their earnings on Friday. Investors had hoped to hear similar numbers from Pfizer. Shares fell on the earnings and the imploding Dow.


Harley-Davidson (HOG) reported earnings of 54 cents compared to estimates for 46 cents. Revenue of $1.05 billion beat estimates for $1.01 billion. These numbers were up from 27 cents and $933.0 million in the year ago quarter. That is where the good news ends. The company said it was going to incur consolidation costs of $170-$220 million and $75 million in capital costs over the next two years. The consolidation of plants would save them $65-$75 million annually after 2020.

The company said Q4 sales declined 9.6% year over year with sales down -11.1% in the USA. Industry sales were down -6.5%. Overall shipments by Harley in 2017 were the lowest in six years. The company said the customer base was getting older and younger customers were lukewarm to the brand. They lowered 2018 guidance for shipments of 231,000-236,000 motorcycles, down from actual shipments in 2017 of 241,498 and its prior 2018 forecast of 241,000-246,000. Shares fell 8% on the lowered guidance.


Polaris Industries (PII) reported earnings of $1.47 that matched estimates. Revenue of $1.43 billion beat estimates for $1.35 billion. They guided for the full year for earnings of $6.00-$6.20 per share compared to estimates for $6.03. However, revenue guidance for 3%-5% growth was well below the 9% analysts were expecting. Shares fell $18 on the news.


Aetna (AET) reported earnings of $1.25 that beat estimates for $1.18. Revenue of $14.74 billion missed estimates for $14.89 billion. CVS is in the process of acquiring Aetna for $69 billion. Shares fell $6 on the earnings.


Harris Corp (HRS) reported earnings of $1.67 that blew past estimates for $1.40. Revenue of $1.54 billion beat estimates for $1.48 billion. They guided for the full year for earnings of $6.30-$6.50, up from $5.85-$6.05. Revenue guidance of $6.08-$6.14 billion was up from $6.02-$6.14 billion. Shares soared for a $9 gain.


After the bell, Advanced Micro (AMD) reported earnings of 8 cents that beat estimates for 5 cents. Revenue of $1.48 billion beat estimates for $1.41 billion. They guided for Q1 for revenue of $1.5-$1.6 billion and analysts were expecting $1.25 billion. Unfortunately, they backtracked on the comments the Meltdown and Specter hacks would not be material to results. Now they fear the Specter hack could be costly and the efforts to fix the security flaw in their chips could be ineffective.

Nearly every computing device made by AMD, Intel and ARM Holdings over the last 20 years contains the design flaws that "could" allow hackers to steal information. Shares fell -5% initially but rebounded to flat in afterhours.


Juniper (JNPR) reported earnings of 53 cents compared to estimates for 52 cents. Revenue of $1.24 billion narrowly beat estimates for $1.23 billion. The company guided for earnings of 25 cents and revenue of $1.05 billion in Q1. That was less than the 42 cents and $1.15 billion analysts were expecting. The company said the weakness came from delays in installations by key customers and did not impact ongoing sales or market share. Shares fell $2 in afterhours.




Markets

It would be really hard to come up with a comprehensive forecast for the markets on Wednesday. The markets closed near the lows for the day and there was no rebound at the close. Typically, when the markets are going to rebound from a big dip they tend to show some signs of buying at the close. On Tuesday, there was actually some sell on close orders but they were light.

We all know the market was very overbought and was due for a rest. Declining -1.75% in two days is a decent drop but it only took us back to where we were trading last Monday. We have gone for more than a year without a material decline and two days, even at -1.75%, is not much given our recent gains.

I would love to jump in and buy the dip but as I wrote on Monday night, I would not jump in on the first drop. We could easily see an intraday rebound attempt that gets slammed again OR could just explode higher again on Wednesday. The recent pattern to triple digit losses is that they were followed by triple digit gains. Will that happen again? Nobody can tell tonight.

The futures are mildly positive at +3 while the SOTU speech is in progress. That is good so far. That means nothing has been said to tank the market at this point. A positive speech should be good for the market.

Last week Bank of America warned of a potential imminent sell off of 5.6% to 2,686. The S&P declined today to 2,820. A forecast is an opinion not a guarantee. If we were going to return to the long-term uptrend line that would be about 2,650-2,700 depending on the speed of the decline. The 100-day average is currently 2,622 and I have written about that several times recently. The 50-day average is 2,700 and far more likely to be hit but maybe not until mid February.

I still believe we have a good chance of remaining in our present range until the first full week of February when the earnings activity begins to decline.


The Dow has 8 more components announcing earnings this week. Boeing could be the most volatile on Wednesday. The stock has been the biggest supporter for the Dow and any disappointment could be ugly. I do not expect it but nobody expected the Amazon, JPM announcement either. The Dow declined -411 points at its lows.

Initial support is 26,000 followed by 24,700 and that would be a long drop.


The Nasdaq declined only 0.85% compared to the -1.4% on the Dow. I believe that is because investors were hanging on to their big cap techs in hopes of blow out earnings this week. I hope they are not disappointed. The index has initial support at 7,400 but then a sizeable drop to 6,900 if the market continues to be weak.



The Russell 2000 came to a dead stop at 1,580 and exactly uptrend support. This was encouraging. Any further decline could test 1,550. The small caps are not as overbought as the big caps but in any material market decline, they tend to get slaughtered.


I sincerely hope the market explodes out of the gate on Wednesday and the two-day decline was a onetime event. Hope is not a successful trading strategy but it is one investors rely on constantly. If the market opens higher, beware of a lower high where the bounce is sold. If you are going to buy the dip, try to wait until you see a rebound with decent volume and velocity before jumping in.

Enter passively, exit aggressively!

Jim Brown

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