The market volatility is increasing with the Dow falling -136 at the open and rebounding 292 points to the intraday high before falling -219 points ahead of the close.

Market Statistics

The market volatility is increasing to the point that trading is the equivalent of trying to cross a freeway blindfolded. The major indexes have successfully tested support for three consecutive days. They may be successful again but how many times do you have to stomp on pond ice before you fall through. We do not know if the record cash inflows into passive funds will continue or when the river will run dry.

The Nasdaq spent most of the day in negative territory despite rebounding +65 points from the opening low. With both positive and negative reversals intraday, it is almost impossible to trade this market because there is no direction. Investors were rewarded with the vertical ramp higher in the first four weeks of 2018 but that daily rally to new highs has run into a roadblock of volatility.


Some analysts were blaming the sharp rise in yields for the volatility in the market. In theory, when money is flowing out of bonds and yields are rising, the equity market should be seeing large inflows of cash. In reality, with the government is flooding the treasury market with new debt and the Fed is winding down their QE program, the supply of treasuries is rising and that is soaking up excess funds that could have eventually found their way into equities. According to Bill Gross, the bear market in bonds has begun and billions of dollars will be flowing out of treasuries every day. That is a recipe for higher yields and long term it should benefit equities until the yield on a risk free treasury becomes high enough to reverse the money flow again. The relationship between bonds and equities is confusing for most investors so the "blame it on higher yields" excuse is readily accepted.


The morning opened with a flood of economic data that was mostly positive. Weekly jobless claims at 230,000 were down from the 231,000 the prior week and 25 states reported a decline in filings. These numbers are a little higher than the 216,000 for January 13th, which was the lowest level since February 24th, 1973. The labor market is in great shape and suggests the economy is booming.

The ISM Manufacturing for January declined very slightly from 59.3 to 59.1 but all of the components were positive. New orders remained healthy at 65.4 and order backlogs rose from 54.9 to 56.2. Employment declined slightly to 54.2 but the first month of the year is normally choppy for employment as seasonal workers are released and companies gear up for their expectations for the full year.

With the dollar continuing to decline, manufacturers should do well and exports should rise. Inventories rose from 48.5 to 52.3 and that component feeds into the GDP calculations suggesting Q1 could be stronger than previously expected. Only 2 of 13 industries reported a decline in activity and those were nonmetallic mineral products and printing.

On the downside the prices paid component rose from 68.3 to 72.7 and the highest level in a long time. This suggests inflation is finally rising and that competition is increasing for raw materials.



Construction spending for December rose +0.7% after a +0.8% rise in November. Analysts were expecting a +0.4% rise. Private construction spending rose +0.8% and public spending rose +0.3%. Construction spending is 2.6% higher than December 2016. The report was ignored.

The Challenger Employment report for January showed a 37.7% rise in announced job cuts to 44,653. The majority of the layoffs, 15,378, came from the retail sector with announced store closings after the holiday shopping season ended. While the spike appears high, it was still -2.6% below the January 2017 levels. This is a normal seasonal fluctuation and has no bearing on national employment. This was only the second rise in layoffs in the last five months.

The various positive economic reports over the last several days has catapulted the Atlanta Fed real time GDPNow forecast for Q1 growth from 4.2% on January 29th to 5.4% today. That is a monster spike in expectations, especially since Q1 numbers have averaged only +0.8% growth over the last 8 years. Any number over 3% growth for Q1 would be very good for the market. While I do not expect it, a 5% number could be negative because it would suggest the Fed would accelerate their tightening cycle. There are still three months before we get the actual Q1 GDP numbers from the BEA and I would expect some serious fluctuation between now and then.

The calendar for Friday is headlined by the Nonfarm Payrolls. Official consensus estimates have not risen from the 180,000 level despite the ADP report on Wednesday posting a strong 234,000 number with estimates for 185,000. The whisper number for Friday is 200,000. The ADP report is from businesses where the Nonfarm report is businesses plus government but there are different survey methods used.

The government funding deadline is not getting much press this week but we can expect that to heat up rapidly as we move closer to next Thursday. The current expectation is for another shutdown that could be longer and more hostile than the prior shutdown. With earnings peaking this week and next, the market may not be as unconcerned as it was two weeks ago.


The earnings calendar for Friday is dominated by energy stocks. Exxon, Chevron, Weatherford, Phillips 66 and Imperial Oil lead the list. Other notables are Merck, Manpower, Sprint, Spirit Aerosystems, Weyerhaeuser and Sony.

Dow component DowDuPont (DWDP) reported adjusted earnings of 83 cents compared to estimates for 67 cents. Revenue of $20.07 billion beat estimates for $19.37 billion. They guided for 2018 for earnings of $3.90-$4.05 and that was less than estimates at $4.22. They raised chemical prices 5% in Q4 suggesting demand is strong. They will receive a $1.1 billion benefit from tax reform. Shares fell -3% on the news.


Alibaba (BABA) reported adjusted earnings of $1.63 and analysts were expecting $1.67. Revenue of $12.8 billion beat estimates for $12.6 billion. Their cloud business more tha doubled to $553 million in Q4. The ecommerce division saw revenue rise 57% to $11.3 billion. The company said it had 580 million monthly active users, up 31 million for the quarter. Alibaba said it would buy a 33% stake in Ant Financial, which will pave the way for an IPO later in the year. No cash will change hands. Ant will end royalty payments, which totaled $332 million in 2017 and Alibaba will transfer some intellectual property to Ant in exchange for the shares. Jack Ma spun Ant, containing Alipay, out of Alibaba just before the IPO in 2011 and generated a lot of controversy since potential investors expected the IPO to contain Alipay. Ant just saw a merger with MoneyGram fail in the last couple of months and competition from WeChat for payment services has reduced their market share on payments to 54%.

Alibaba said revenue in 2018 is expected to grow 55-56%, up from prior guidance of 49-53%. The company is rapidly acquiring multiple brick and mortar retailers including supermarkets and department stores. This caused margin shrinkage from 39% to 31% in Q4. Shares fell $12 on the news.


UPS reported adjusted earnings of $1.67 that beat estimates by a penny. Revenue of $18.83 billion rose 11% and beat estimates for $18.19 billion. They guided for 2018 for earnings of $7.03-$7.37 and analysts were expecting $7.21. UPS plans to spend $6.5-$7.0 billion on capex projects in 2018. Volume was so heavy in December they had to add short-term capacity that incurred an extra $125 million in expenses. For the entire holiday season, they delivered 762 million packages. For the entire quarter, deliveries rose 5.7% to 1.5 billion packages. They said as a result of tax savings they will be investing $12 billion in expanding their Smart Logistics Network, increase pension funding and create additional value for shareholders. They are purchasing 18 new planes including 14 747s and 4 767s. Analysts were lukewarm on the earnings and shares fell $8 on the news.


Autonation (AN) reported earnings of $1.02 compared to estimates for 93 cents. Revenue of $5.7 billion beat estimates for $5.55 billion. However, it was only slightly higher than the $5.5 billion in the year ago period. The better earnings came from higher prices on used vehicles. The average profit per used vehicle rose 6% to $1,344 while the profit on new vehicles declined -6% to $1,847. Shares fell -3.6% on the news.


MasterCard (MA) reported earnings of $1.14 that beat estimates for $1.12. Revenue of $3.31 billion beat estimates for $3.26 billion. Gross dollar volume of charges rose 13% to $1.4 trillion. Switched transactions rose 17% to $17.7 billion and cross border volumes rose 17%. Shares rose $4 on the news.


Visa (V) reported earnings of $1.08 that rose 22% and beat estimates for 98 cents. Revenue of $4.86 billion beat estimates for $4.82 billion. They guided for 2018 revenue growth of high single-digits. Investors were not happy with the news and shares declined $2 in afterhours.


Alphabet (GOOGL) reported earnings of $9.70 that missed estimates for $9.98. Net revenue of $25.87 billion beat estimates for $25.57 billion. Traffic acquisition costs soared from $4.85 billion to $6.45 billion. Gross revenue rose 24% to $32.3 billion and beat estimates for $31.9 billion. Advertising revenue rose 48% despite the average user spending less time on their phones and on YouTube. Google shares fell from the $1,181 close to $1,104 in afterhours but rebounded to trade at $1,155 late in the session.

John Hennessy is replacing Eric Schmidt as Chairman of the board. Hennessy has been on the board since 2004 and was the lead independent director since 2007. This move had been expected.


Apple (AAPL) reported earnings of $20.07 billion or $3.89 that rose 15.7% and beat estimates for $3.82. Revenue of $88.29 billion rose 12.6% and easily beat estimates for $86.29 billion. The company guided for Q1 revenue of $60-$62 billion. Analysts were expecting $65.3 billion. The company sold 77.3 million iPhones, down from 78.3 million in the year ago quarter. Analysts were expecting 80 million. Tim Cook said the record iPhone revenue was due to the iPhone X being the top selling phone every week since it was introduced. "Other" revenue which included Apple TV, Apple Watch and Beats products rose 35%. Services revenue, which included iCloud, Apple Music and the App store, rose 18% but that was lower than expected.

The average selling price of an iPhone rose to $796 and beat estimates for $756. Apple will pay $38 billion for repatriation of cash and said they would reduce their debt significantly with the cash return. Their current cash on hand rose to a record $285.1 billion. Shares initially fell to $162.50 in afterhours after closing at $167.78 but rebounded to trade over $173 late in the session.


Amazon shares surged almost $90 in afterhours after reporting earnings of $3.75 that blew past estimates for $1.88. That is a profit of $1.9 billion and was the first time in history that profits were more than $1 billion for a quarter. Revenue rose 38% to $60.5 billion that beat estimates for $59.8 billion. They guided for the current quarter for revenue of $47.75-$50.75 billion compared to estimates for $48.6 billion. Retail sales revenue was $37.3 billion with Amazon Web services hitting $5.11 billion, up 46%.

Jeff Bezos said 2017 estimates for Alexa were very optimistic and we far exceeded them. "We do not see positive surprises of this magnitude very often. You can expect us to double down" meaning he is going to spend that cash on new, bigger, better and more surprising endeavors as he conquers the retail world. Amazon said they sold "tens of millions" of Alexa devices. The Prime program is exploding with more than 5 billion items shipped to Prime members.

Shares had declined -$60 to close at $1,390 in the regular session but rebounded to close in afterhours at $1,475 and a new high if that holds on Friday. This is a chart in desperate need of some profit taking but nobody wants to sell.


GoPro (GPRO) reported a 30-cent loss that missed estimates for an 11 cent loss. Revenue of $334.8 million declined -38.1% and missed their own guidance for $340 million. They took an $80 million hit from discounting their Karma drones and Hero cameras. They are exiting the drone business. They cut the Hero camera prices by $100 to $399. They hired JP Morgan to find a buyer for the business, which had a $10 billion market cap at one time. They now have a market cap of $600 million or just under twice their Q4 sales. Shares dipped in afterhours but at $5, it was barely noticeable.


Mattel (MAT) reported a loss of 72 cents compared to estimates for a profit of 16 cents. Revenue for the holiday quarter was $1.61 billion, a decline of 12%, compared to estimates for $1.69 billion. They blamed the loss on the Toys-R-Us bankruptcy and a 23% decline in sales of American Girl Brands, which is products tied to dolls. Sales for that product line are down -21% for the year.


Tesla (TSLA) said it was expanding its solar division to setup displays in more than 800 Home Depot stores. Since Tesla's solar products are 2-3 times more expensive than regular solar, this is a good move because shoppers may not realize the difference in prices. The displays will also sell the Powerwall battery systems. Lowe's has reportedly held talks with Tesla as well but a Lowe's rep said "we do not have any plans to carry Tesla products at this time." Solar City, the prior incarnation of Tesla Solar had previously sold its systems in Home Depot stores and it worked out well for them. Tesla shares were down for the day.





Markets

The Dow opened with a -136 point decline, rebounded 292 points then reversed again to drop -219 points intraday before a burst of buying at the close ended the day with a 37-point gain. You cannot trade that unless you are a computer. Investors were stopped out at the open and about the time they are convinced the market is back in rally mode and reestablish their long positions, the market craters again.

At the risk of sounding like a broken record, this type of volatility is typically seen at market tops and bottoms. This is investor indecision interspersed with end of month buying and selling by funds. The morning rebound was likely end of month fund inflows being put to work in the market. Managers are tasked with making those purchases regardless of market direction. When the money hits the account, they have to spend it. Active managers have a little more leeway but the majority of funds being deposited in 2018 have been into passive ETFs.

Friday could be interesting. After a week of increased volatility and earnings from most of the big cap tech stocks, what would investors buy? They are not going to buy Dow stocks that have already reported and after Friday's open that will be about 25 of the Dow stocks. They are not likely to buy the big cap tech stocks after earnings because of the potential for a post earnings depression cycle. That suggests Friday could either be dormant or be another volatility event. There are probably some fund managers with additional month end inflows that arrived today. They will buy at the open and then clock out for the weekend.

Individual investors are probably not going to invest heavily on Friday because of the week's volatility. It could be an interesting day.

The Dow has tested initial support at 26,000 for three consecutive days and each day saw a decent bounce. With every bounce, it makes that support stronger but eventually the market will have to pick a direction. Given the five months of gains and the peaking of the earnings cycle, there is likely a dip in our future. I am still forecasting the first full week of February through option expiration as the probable soft patch.



The S&P is testing light support at 2,810 and today was the lowest close for the week. Bank of America is targeting 2,686 for a short-term bout of profit taking over the next several weeks. That is an opinion, not a guarantee. The three days of volatility has been the biggest dip since early December. With the earnings cycle peaking, there will be less investor interest in buying the market highs. There is nothing preventing another move higher but each rebound this week has been sold.


Both Nasdaq indexes closed on critical support and were weak for the majority of the day. The big $61 decline by Amazon was the driving force but most of the other big cap tech stocks were also negative.

After the bell, AAPL and AMZN are positive while GOOGL and several of the smaller tech stocks are negative. The Nasdaq futures are up 53 points. The S&P futures were up +8.50 but have declined to -10.50. This suggests the Nasdaq indexes are probably going to open higher on short covering but once that fades, the direction could be negative.

The larger winners and sinners list below, which includes afterhours trades, suggests the list is balanced. Once any opening spike is behind us the market direction will depend on how many investors will want to buy the highs.

The Nasdaq composite closed on support at 7,385 and the Nasdaq 100 closed on support at 6,901. A failure of those levels could trigger a new leg lower while a rebound to the highs is going to meet stiff resistance.





The Russell 2000 shook off the intraday drop to 1,568 to rebound 10 points and close back above support. In today's market, that was a good day. The small caps are not seeing the same volatility as the big caps and the A/D line was 3:2 in favor of advancers. That is an improvement over the higher decline rates earlier in the week.


Personally, I do not see any reason for investors to jump into the volatility on Friday with a lot of bullish buys. The odds are good they will get a change to buy stocks lower over the next three weeks. Of course, a lot of traders do not look past the opening bell with their market analysis so anything is possible. I would always caution against buying a Friday because it is cleanup day and other traders can be adjusting positions plus you never know what headline will appear over the weekend.

Futures have turned significantly negative. The S&P futures opened the evening session at +8.50. They have since declined to -10.50. While this could reverse before morning, the market outlook is rapidly turning bearish.

Enter passively, exit aggressively!

Jim Brown

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