After surging to the best start for January since 1987, markets posted the biggest decline since January 2016.

Weekly Statistics

Friday Statistics

The Dow closed at 26,472 last Friday with a 7.7% gain for the year. The index closed this Friday at 25,521 and a -4.1% decline for the week. A lot can change in a very few days. Art Cashin said there were $1.7 billion in sell on close orders on the NYSE.


Yields on the 10-year spiked nearly 3% to 2.854% on Friday after the Nonfarm payroll report showed wage growth accelerating to a 9-year high of 2.9%. Inflation has been dormant since the financial crisis but has suddenly rocketed higher suggesting the Fed may be behind the curve and will have to accelerate their rate hikes in 2018. However, frigid weather in January reduced the number of hours worked so the wage gains may be a temporary calculation error. Secondly, the onetime bonuses from the tax reform funds should also spike wages temporarily.


Apple ($AAPL) beat on earnings but missed on units sold and gave weak revenue guidance for Q1. After spiking $5 in the afterhours session the shares collapsed -$7.28 on Friday to close -10.5% below its $179.26 high and in correction territory. Bernstein cut them from buy to neutral and said the stock was fully valued for a slowing sales environment. Chip stocks that feed Apple were crushed with major declines. Apple shares subtracted 33 points from the Nasdaq.


The Nasdaq Composite lost -145 points and the Nasdaq 100 gave back -141 but it would have been worse except that Amazon added 17 points to the Nasdaq and Charter added 3 points. This offset some of the decline from Apple.


The Dow has lost more than 500 points only 17 times in history. There have only been 8 losses before Friday of more than 600 points. The Dow lost -696 at its lows and had it closed there it would have been the third largest point loss in history. Currently the third largest is -680. There was a minor burst of short covering at the close to lift the index off its lows.

Volume of 9.03 billion shares was the heaviest since the quarterly option expiration and index rebalance on December 17th at 10.7 billion. The A/D ratio was 7:1 decliners over advancers. Declining volume was 6:1 over advancing volume. Across all markets, there were 127 new highs and 525 new lows.

I wrote last week that a marker capitulation was normally determined by a significant imbalance in the A/D line of 8:1 to 10:1 with heavy volume. While 9.03 billion shares was high it was only about 15% over the recent average. On a purely technical basis, Friday was a strong retracement but it was not a true capitulation day. There is a stock market adage, "Markets rarely bottom on Fridays." When bearish sentiment appears suddenly, there is always the fear of the unknown over what could happen over the weekend. Markets do bottom on Mondays. It is not unusual after a Friday Flush for the markets to open sharply negative on Mondays and then rebound before the day is over.

If you surveyed traders the prior Friday and asked them what the market needed to do to deflate the overbought conditions and provide a dip to buy, they would probably have said a 3% to 4% decline. Now that we have had a -4.1% decline on the Dow, I did not see a lot of buying at the close. Everybody wants somebody else to go first.

Most of the market commentators were blaming the Nonfarm Payroll report for the sell off Friday morning. However, the S&P futures were down -15 at 4:AM and the Dow futures were down -200 before the payroll report was even released. I wrote about this last week that market commentators will always try to find something to blame for the dip because it makes them look knowledgeable on TV.

I have no doubt the report added to the bearish sentiment but it was not the trigger for the initial decline.

The report showed a gain of 200,000 jobs and slightly over the consensus forecast for a gain of 185,000. The unemployment rate remained flat at 4.1% along with the labor force participation rate at 62.7%.

The killer line item in the report was a +0.3% jump in hourly wages to 2.9% year over year. That is the fastest rate in nine years. This immediately spiked fears that inflation was suddenly accelerating and the Fed would have to hike 4 or even 5 times in 2018 to slow down the economy. The current consensus is for 3 rate hikes in 2018. Bull markets do not die of old age. They are killed by higher interest rates or recessions.

The previously reported December payrolls of 148,000 were revised higher to 160,000. The November numbers were revised lower from 252,000 to 216,000. Construction added 36,000 jobs, food service +31,000, healthcare +21,000, retail +15,000 and manufacturing +15,000. A whopping 518,000 people entered the workforce. Household employment rose 409,000 for January but 318,000 were due to an accounting change.


The NY - ISM report posted a monster rise from 56.3 to 72.5 for January. That is the highest reading since 2006. Employment surged from 42.9 to 58.4. The biggest negative component was the six-month outlook which fell from a 10-yr high of 85.7 in December to a 2.5 year high at 76.1 in January. That took it out of the great category and back down to just really good. The headline number at 72.5 and the six-month outlook at 76.1 are both over 70 for just the second time since 2010.

The final reading of consumer sentiment for January rose from 94.4 to 95.7 and five points below the 18-year high of 100.7 in October. The present conditions component declined from 113.8 to 110.5 and the expectations component rose from 84.3 to 86.3. Of the survey respondents 77% said it was a good time to buy a major household item, 66% said it was a good time to buy a car and 67% thought it was a good time to buy a home.


Factory Orders for December rose 1.7% and the fifth consecutive monthly gain. Three of those months have seen an identical 1.7% increase. Durable goods orders rose 2.8% with nondurables rising 0.7%. Backorders rose 0.6% and defense orders rose 19.2% for the third increase in four months. This report was ignored.

We have a very light economic calendar for next week with only two material reports. There are seven Fed speeches. The biggest event is the government funding deadline on Thursday evening. However, lawmakers are already talking about kicking the can down the road again and putting it off until March 22nd. Several representatives have already said they would not vote for another extension unless there were major changes in the plan. They will probably come around because everyone caught flack from the three-day shutdown two-weeks ago. While they cannot agree on the actual funding and immigration issues, they can agree they do not want their phone lines to light up again with complaints.

March 5th is the deadline for a DACA resolution. That is not likely to happen either. The next two months will be continuous partisan headlines until they wade through some of these issues.

Janet Yellen officially stepped down as Fed chairman on Friday and will begin work at the Brookings Institute on Monday as a fellow in economic studies. She will join Ben Bernanke, Donald Kohn, Alice Rivilin and Alan Blinder, all prior Fed members. Jerome Powell will be officially sworn in as chairman on Monday.


The earnings calendar for next week has very few highlights. There is only one Dow component, which is Disney on Tuesday. Gilead, Tesla, Nvidia and Twitter will be the most watched names. Akamai, Chipotle Mexican, Yum Brands and Activision will probably generate a lot of interest as well.

There are 93 S&P companies reporting, down from the 125 last week. To date, 251 S&P companies have reported with 78.1% beating on estimates and 79.7% beating on revenue. The blended earnings growth estimate for Q4 is now 13.6% and revenue growth of 7.7%. There have been 27 guidance warnings and 27 companies gave positive guidance. The forward PE is 18.4.

With the number of large high profile companies falling sharply from last week, there will be less earnings excitement and anticipation in the market. The coming week is when I expected some profit taking volatility to appear with the following week volatile as well. After the flush last week, the future volatility could fade. Stops have been hit and many of the weak holders have been eliminated.


There were not a lot of earnings on Friday but there were some big names. Dow component Exxon (NYSE:XOM) reported earnings of 88 cents that missed estimates for $1.03. Revenue of $66.5 billion also missed estimates for $71.9 billion. Production of 3.99 million bpd fell well short of estimates for 4.165 million bpd.

In addition, Exxon said it will see a $5.942 billion benefit from tax reform. They are going to launch a $50 billion capex program over the next five years to triple production from the Permian to more than 600,000 bpd, expand operations, improve infrastructure and build new manufacturing sites. The improved infrastructure and additional production will provide a low-cost supply of feedstocks for downstream refineries and chemical operations in Texas and Louisiana. These facilities produce high demand plastics, chemicals and synthetic lubricants.


Dow component Chevron (NYSE:CVX) reported earnings of 72 cents that missed estimates for $1.22. Revenue of $37.62 billion barely topped estimates for $37.55 billion. Production of 2.74 million Boepd was up slightly from the 2.67 million Boepd in the year ago quarter. Their average price received for oil was $50 in Q4, up from $40 in the year ago period. Chevron said Q4 production was hurt by hurricanes, outages at their massive LNG plants in Australia and asset sales. They added 1.54 billion barrels of proved reserves in 2017 and replaced about 155% of net production for the year. They also announced a major discovery at the Ballymore prospect in the Gulf of Mexico in 6,536 feet of water. The initial exploration well found excellent fluid properties and more than 670 feet of net oil sands. They have a 60% stake in the prospect. It is only three miles from the Blind Faith platform, which will make it easier to commercialize the production.

The company announced a quarterly dividend of $1.12, up from $1.08, payable March 12th to holders on February 16th. Chevron has raised their dividend for more than 25 consecutive years.


Este Lauder (EL) reported earnings of $1.52 that beat estimates for $1.44. Revenue of $3.74 rose 17% and beat estimates for $3.67 billion. They guided for the current quarter for earnings of $1.02-$1.04 and analysts were expecting $1.01. For the full year they guided for $4.27-$4.32, up from $4.04-$4.12 and beat estimates for $4.20. They announced a dividend of 38 cents payable March 15th to holders on February 28th. Shares faded from their opening high in the weak market.


Clorox (CLX) reported earnings of $1.23 that beat estimates by a penny. Revenue of $1.42 billion missed estimates for $1.43 billion. They guided for full year earnings of $6.17-$6.37 per share. Analysts were expecting $6.16. Investors were not happy and punished the stock with a $9.50 drop.


Charter Communications (CHTR) reported earnings of 86 cents that beat estimates by a penny. Revenue of $10.6 billion beat estimates for $10.58 billion. They added 15,000 new video customers, 300,000 new internet customers and 53,000 new voice subscribers. In the world of cable cutting this was an outstanding report. Shares exploded higher for a $16 gain in a weak market and added 3 points to the Nasdaq.


Merck (MRK) reported earnings of 98 cents that beat earnings for 94 cents. Revenue of $10.43 billion missed estimates for $10.49 billion. The company recorded a loss of $125 million as the result of the June cyber attack. Sales of Januvia, Keytruda and Gardasil beat expectations. The company guided for full year revenue of $41.2-$42.7 billion compared to estimates for $41 billion. They guided for earnings of $4.08-$4.34 and analysts were expecting $4.10. They announced plans to invest $8 billion in US capital projects over the next five years with $12 billion planned in total. They also announced bonuses for employees as a result of tax reform. Shares had been declining since the "lower drug prices" pledge by President Trump on Tuesday.


Just when you thought Elon Musk had run out of ideas, he comes up with an even wilder product. Musk sold 20,000 $500 flamethrowers in four days and raised $10 million for his tunnel boring company named The Boring Company. Yes, I said flamethrowers. He joked on twitter that the device was sentient and its safeword was "cryptocurrency" and comes with a free blockchain. Here is a video with Musk demonstrating it. Video Never a dull moment.


Tesla also sold $546 million in auto lease-backed bonds on Thursday. The securities were sold to yield between 2.3% and 5.0%. At the initial prices, the offering was oversubscribed by 14 times. The leases are on its Model X and S vehicles. Since Tesla is expected to burn through $4.2 billion in cash in 2018, the company will obviously be selling more debt in the near future. Tesla plans to become a regular issuer of ABS securities.

The governing body of auto racing (FIA) has approved a series of races where 20 drivers will race the fully race-prepared Tesla Model S P100D in the Electric Production Car Series. There will be a three heat qualifying format and then two 60 kilometer races, one in daylight and one at night. There will be a cap on horsepower at 778 hp and roughly the same level as a Formula 1 car. The cars will have 1,100 pounds of weight removed to make them even faster. Since they can accelerate from 0-60 in 2.2 seconds, I cannot imagine how fast they will be 1,100 pounds lighter. In theory, the Electric Production Car series is to pit cars from different manufacturers against each other but there is a shortage of high performance cars other than Teslas so they will have the track to themselves until other competitors appear.


Musk recently received a new 10-year contract where he will receive nothing in guaranteed salary, options, bonuses, etc. His compensation will be tied to manufacturing goals and company market cap. Tesla has a $60 billion market cap today. For every $50 billion in additional market cap, he will be awarded 1% of the outstanding stock. Today that would be a $584 million award. The goal is to reach $650 billion in market cap within 10 years. If he succeeded in accomplishing that goal along with the manufacturing milestones, his total compensation over that period would be $55 billion. That is a serious goal. Any shares awarded throughout the 10-year contract must be held for an additional 5 years from the date of vesting just to make sure regular shareholders are protected.

Lastly, Musk is negotiating with Anheuser-Busch, PepsiCo and UPS to build on-site charging terminals at their facilities as part of the electric truck project. Pepsi has committed to buy 100 Semis and UPS ordered 125 as a test project. Tesla is trying to get these companies to install Tesla Solar and commercial Powerwall installations to recharge the trucks. The solar would recharge the Powerwall batteries during the day and the Powerwalls would recharge the trucks at night. This would significantly reduce the electrical cost to power the trucks and improve the operating metrics. That would be a win-win for Tesla to convince companies to buy all three products. If it works as expected, it could set the pattern for new purchasers for years to come.

So, the key question today is whether investors buy Tesla shares in hopes that Musk accomplishes his goal and boosts the market cap from $60 billion to $650 billion within 10 years. That would take the shares from $345 today to $3,450 by 2028. Any takers?


It was a rough week in crypto currencies. More than $100 billion in market cap was erased from the crypto market. Bitcoin declined from $12,000 last weekend to $7,900 (-33%) intraday on Friday. That was down from $19,000 in December. India said they wanted to eliminate the use of digital currencies in criminal activities suggesting much tighter regulation was coming. South Korea, China and others are also pursuing everything from strict regulation to outright bans.

There is also a considerable amount of worry over Tether. This is a digital currency that is supposedly pegged to the US dollar. One tether equals one dollar. For that to work, Tether Limited would have to have $2.2 billion dollars on deposit somewhere to offset the 2.2 billion tether tokens. Tether Limited has supplied what it called "proof of deposit" confirmations but the names of the banks were blacked out so there is no way to prove those are real.

The actual problem for the crypto community is that tether is being used as a currency to buy other currencies like bitcoin. Holding fiat cash in a currency exchange is dangerous so people immediately buy tether since it is a $1 for $1 exchange rate. They do not have to worry about the coin fluctuating significantly. Then they can use their tether to transfer from exchange to exchange and buy other currencies. Numerous analysts have pointed out that new "grants" of tether coins always seem to occur when bitcoin is hitting its highs. The Bitfinex exchange is owned by the same people that own Tether Limited. In January alone Tether Limited has released 850 million new digital tokens into the Bitfinex wallet and the release dates tend to coincide with bitcoin highs. Critics claim Tether Limited is using the tether coins to prop up bitcoin and thereby support the entire crypto currency market. One analysis showed that 48.8% of the rise in bitcoin prices occurred in the two-hour periods following the arrival of 91 different tether grants to the Bitfinex wallet.

The CFTC has subpoenaed Bitfinex and Tether Limited and there has been no further news on that investigation. According to Coindesk, Friedman LLP, the accounting firm that previously audited Tether Limited/Bitfinex has cut ties with the companies and said the two parties had dissolved their relationship.

The problem could be huge. If tether has been propping up bitcoin and is now having financial problems and the investigations cause traders to be alarmed, they could try to redeem their tokens for dollars and basically cause a run on the tether bank. That would prevent tether from propping up the bitcoin market and the market in general and the entire crypto currency balloon could implode. Because these headlines and stories are becoming more common, we could already be seeing a run on the entire currency space. Bitcoin declined 33% last week to levels not seen since November. With no inherent value in crypto currencies, there is extreme risk of bad actors perpetrating all kinds of schemes. If you have crypto currencies, watch the headlines very carefully.


Crude prices only declined 74 cents on Friday but the energy sector was one of the biggest decliners with a -4.2% drop. The key was obviously the missed earnings by Chevron and Exxon but the sector drop began last Monday as investors worried about the approaching seasonal weakness. The US added 6.8 million barrels to inventory and the first addition since November 17th. Inventories typically rise over the next two months and prices decline.





Markets

The AAII Sentiment Survey that closed on Wednesday saw only a minor change in bullish sentiment but neutral investors were rapidly moving to the bearish camp. The Dow fell -177 points on Monday but the bulls were sticking it out. It will be interesting to see next week's survey after the Dow lost nearly 1,100 points for the week.


Bank of America reported another $25.7 billion in inflows to equity funds in the week ended on Wednesday. Equity and index ETFs garnered $22.4 billion of those funds. That brought the total for January to a record $102.7 billion. Citigroup said ETFs pulled in a record $79 billion in January including $42 billion into stock funds. That is not a typo; the totals for BAC and C do not match.

The money flows confirmed the Bank America, Merrill Lynch sell signal on their Bull/Bear Indicator. The indicator triggered a sell signal the prior Tuesday and confirmed it last Tuesday. The indicator has given 11 sell signals since it began in 2002 and has been right on every one. This was the 12th sell signal and it was also right. The indicator has a perfect record and we should pay rapt attention the next time it is triggered. BAC is projecting a drop on the S&P to 2,686 or -6.4% in the coming weeks. The S&P was down -3.85% last week so not much farther to go if they are right. The bank has a 3,000 price target for year-end and a bullish case target of 3,100.

The last time the Dow declined more than 600 points was June 24th, 2016 and the day after the Brexit vote. The Dow has only declined more than 600 points on eight prior days. However, the higher the index goes the more common declines of this magnitude may become. The decline on Friday was the fifth largest drop but it was the smallest percentage move. In the future when headlines prompt a selloff we could expect to see larger declines. There are five 7% moves on that list. A 7% decline today would be -1,786 points. We will see that at some point in the future but hopefully not for a long time.


There was no green on the component graphic for Friday. The A/D line was 30:0 decliners to advancers. Goldman cost the Dow nearly 85 points to be the biggest loser but there were a lot of big losers that contributed to the -666 loss. The stock that surprised me the most was Nike with only a 43-cent decline. That stock has been rebounding for three months but apparently, nobody wanted to sell it.


The Dow crashed through 26,000 and appears headed for a test of uptrend support in the 25,250 range. The ideal scenario would be a -250 drop to that level at the open on Monday and then a strong V bottom rebound to close positive. The chances of that happening are slim and none but we can always wish. There is bound to be some dip buying on Monday but there could also be some new sellers. Investors who did not sell on Friday and have had to rethink that 666-point loss all weekend, could decide to bail on Monday.

Even if the Dow does rebound, we should be wary of a new sell cycle on any bounce. A decline this severe is rarely over in one day. The market may rebound but it it not likely to be vertical but days of choppy gains and losses.


The S&P declined 2.1% on Friday and -3.85% for the week. That is the biggest decline since the market collapse in January 2016. The obvious target on any continued decline is the 50-day average at 2,715. When coupled with Bank of America's high profile call for a drop to 2,686, they are both in the same general area. Those would be a 5.5% to 6.4% decline respectively. There is light support around 2,735.


Thank you Amazon and Charter. Without those two stocks, the Nasdaq indexes would have been about 20 points lower. The big cap tech stocks had a rough day but it could have been worse. Facebook only declined -2.80 and Broadcom -3.30. Those are normal declines for those stocks and not a crash. Microsoft was slightly out of character with a -2.50 drop. That stock rarely moves that much in a single day. The last time was December 4th and the time before that was June 9th. With nearly 8 billion shares outstanding, it is hard to generate a big move.



The Nasdaq Composite has multiple areas of light support but the best technical support is the 30-day average. The index has bounced from that level multiple times over the last six months. That is currently 7,203. Below that, there are multiple levels of light support at 7,135, 7,115 and 7,040. I would not expect the index to move that low but anything is always possible.


The Nasdaq 100 tends to over penetrate the 30-day by a few points so that makes the 6,700 level a natural target.


The small cap Russell declined slightly below prior resistance, now support at 1,550 but closed near enough for it to still have an impact. The percentage decline for the week at -3.8% was the same as the S&P so it was not leading the pack but keeping pace. The A/D line on the small caps was almost 11:1 in favor of decliners. They had been weakening for several days.


The US equity markets lost nearly $1 trillion for the week. That is real money and I am sure there are plenty of millennial investors that have never lived through an actual market crash.

Volatility increased significantly with the VIX rising 27% to 17.16. However, the VIX futures ETF only rose 13.5%. The volume was unbelievable. The VXX has roughly 33.5 million shares outstanding. Of those, 32.8 million are short because it is a futures product and it always goes down eventually. The volume on Friday was 130 million shares or 4 times the outstanding shares. The algo computers must have been having a field day because there is no way that came from individual investors.


I would recommend watching the open on Monday. Anything is possible. If you must buy the open, you are probably going to have to go naked and avoid stop losses. Even if the market eventually rallies by day's end, the opening volatility could be huge. We could move in both directions in a hurry. Of course, the Dow has been moving in alternating 250-point intraday moves for a couple weeks so that is not new.

I do believe there will be a tradable move higher before the market finally moves lower ahead of February expiration. The key word there is tradable. While I am going to recommend new positions in the various newsletters this weekend, they are not for the faint-hearted. The only guarantee for next week is that there will be volatility. There is no guarantee of direction.


I am sorry to tell you that Keene Little has been forced to leave Option Investor after 14 years. His dad's health has worsened and Keene has moved to be able to take care of him. The constant daily care has made it impossible for Keene to concentrate on the market and he regretfully had to give up his weekly market commentary for the foreseeable future. I would ask that everyone keep Keene and his family in your prayers in the weeks ahead.

Enter passively and exit aggressively!

Jim Brown

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"You will never reach your destination if you stop and throw stones at every dog that barks."

Winston Churchill


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