Last week's hurricane of volatility has passed over. Is this the eye of the storm?

Market Statistics

A hurricane arrives with rapidly increasing wind and rain that peaks just before the eye of the storm arrives. That eye is a period of relative calm where a few cautious people begin to step out of their protective surroundings. Shortly thereafter, the backside of the storm arrives to send them scurrying back to cover. The backside is normally weaker than the front side of the storm.

We have experienced three days of market gains with lower volatility that was almost calm after Tuesday's open. Is this the eye of our volatility storm? Should we be expecting the backside to hit us at any time?

That may be what investors are worried about. Buying momentum slowed on Monday afternoon as the indexes plateaued. Today the market gapped lower at the open to lose -180 points. The Dow traded in roughly a 100-point range until 1:15 when there was a sudden spike across all the indexes. The Dow quickly settled into another 100-point range for the rest of the day.

This shows an almost complete lack of conviction by both buyers and sellers. Buyers appeared to be worried there will be a retest of the lows so they are hesitant to place big bets. Sellers appear to be exhausted after last week's record sessions. I am encouraged by the three days of gains but the VIX only declined 0.64 today. We need to see the decline accelerate to indicate investors are dumping their puts because they are no longer afraid of a second dip.



The economic reports were positive but ignored. The NFIB Small Business Optimism Index for January rose from 104.9 to 106.9. That was just below the cyclical high of 107.5 in November. The internal components were relatively flat. Employment was unchanged at 20 with job openings rising slightly from 31 to 34. Companies believing it was a good time to expand rose from 27% to 32% and those planning to increase capex spending rose from 27% to 29%. Those expecting sales to increase declined from 28% to 25%. This report was consistent with a GDP over 4%.

The National Association of Realtors reported their metro price index rose 5.3% for Q4 compared to Q4-2016. The gains came from the scarcity of listings and moderate demand. The tight supply is the driving force. Many buyers have already been priced out of the market and rising interest rates will eventually remove even more potential customers. This is a lagging report, covered by multiple other monthly reports, and was ignored.

After the bell, the API crude inventory report showed a build of 3.497 million barrels, higher than the 2.825 million expected. Gasoline inventories rose 4.634 million barrels and higher than expectations for 1.229 million. Distillate inventories rose 1.1 million barrels and analysts had predicted a 1.13 million barrel decline. WTI prices declined slightly after the report.


On the calendar for Wednesday is the Consumer Price Index or CPI. Analysts claim Tuesday's lackluster market may have been worries over the potential for an unexpected rise in inflation in this report. Expectations are for a rise of +0.3% compared to +0.1% in December. Some analysts are expecting only a +0.2% rise. If that were the case the year over year inflation rise would be +1.7% and still be under the Fed's target of 2.0%. Analysts worry that a hotter than expected January number could prompt the Fed to begin targeting 4 hikes for 2018 rather than the current assumption of 2.5 to 3 hikes. The reason for the half hike is that the Fed funds futures are split on expected interest rates for later in the year.

A rise of +0.4% could send the market into a nosedive if interest rates began to spike. The yield on the ten-year has been holding at the 2.85% level and after the shock of the initial spike up from 2.6% passed, investors have begun to ignore it again. If inflation came in hot and rates shot up to 3% we could easily see the market weaken again.

A Bank of America report today showed that professional bond investors had cut their holdings to the lowest levels in 20 years. Fund managers claim they have cut their allocations of bonds to a 69% underweight weighting. That is the lowest since Bank of America began the survey 20 years ago. They polled 196 managers with $575 billion under management. The portion of equity investments declined to "only" 43% overweight so managers are still very bullish on equities. Cash balances rose to 4.7%.


The retail sales report for January is also on Wednesday and expectations are for a 0.4% rise. This is too early to see any material bump from the lower tax rates and the hundreds of companies giving bonuses and raising wages so the February report will be the key number.


Earnings will be headed by Dow component Cisco Systems after the close. Applied Materials, Groupon, Marriott, NetApp, Trip Advisor and Agilent will be the most watched.


In earnings today, Under Armour (UA) reported earnings of 1 cent that matched estimates. Revenue of $1.37 billion beat estimates for $1.31 billion. Apparel sales rose 2.5%, footwear 9.5% and accessories 6.1%. International sales rose 47% while North American sales declined -4%. Direct-to-consumer online sales rose 11% overall. They guided for the full year for earnings of 14-19 cents. Analysts were expecting 21 cents. They guided for low single digit revenue growth overall with a mid single digit revenue decline in North America and 25% growth internationally.

This was a completely lackluster earnings report other than the rise in revenue. However, the stock spiked 16% on what analysts were calling short covering.


PepsiCo (PEP) reported earnings of $1.31 that beat estimates for $1.30. Revenue of $19.53 billion beat estimates for $19.39. They guided for the full year for earnings of $5.70 and analysts were expecting $5.67. PepsiCo joined the 400+ companies giving employees bonuses as a result of the tax reform. They will give $1,000 to eligible US employees.

While consumers are dumping the carbonated sugar beverages, the snack business is improving. The snack division saw revenues rise 5% and they contribute 25% of company revenue. The beverage division saw sales decline -3%. Shares were flat on the news.


Shares of Blue Apron (APRN) were volatile but finished flat after reporting a loss of 20 cents that beat estimates for a loss of 27 cents. Revenue of $187.7 million beat estimates for $182.8 million. Active customers declined to 746,000 and -13% lower than Q3 and 15% lower than Q4-2016 when sales were booming because of the new boxed meal fad. In the October quarter customers declined -9% from the 943,000 customers in the June quarter.

These customer numbers are not good and demonstrate how much competition they are facing now that Albertsons bought Plated for $300 million and Amazon is launching the same type of service from Whole Foods without the cost of shipping across the country. The boxed meal fad is having a hard time keeping repeat customers. Consumers try it a couple of times but then drop off the active list. This customer churn is causing everyone grief in this day of restaurants on every corner. It is easier to go out to eat and cheaper in most cases. Blue Apron's only hope is that Kroger or someone similar buys them to compete with Amazon and Plated.


Vitamin company GNC Holdings (GNC) reported earnings of 25 cents that beat estimates for 23 cents. Revenue of $557.7 million missed estimates for $568.8 million. Same store sales rose 5.7% in company stores but declined -2.0% in franchise stores. The earnings were uninspiring but the stock rallied after they announced a $300 million investment from Chinese drug maker Harbin Pharmaceutical Holding. They had been rumored to be expecting an investment for the last year. They have to have access to cheaper vitamins to compete with Amazon. The online retailer is making it tough for GNC as well as Natural Grocers. Kroger and Walmart have gotten into the act with a line of inexpensive vitamins. Since vitamins are not regulated by the FDA, you have to wonder about quality control and actual ingredients from Chinese manufacturers.


After the bell, Fossil (FOSL) reported earnings of 64 cents that blew away estimates for 39 cents. Revenue of $920.8 million also topped estimates for $890.5 million. They reported a 31% increase in e-commerce sales in Q4 thanks to their focus on wearable's. They said that focus would lead to higher margins in 2018. The CEO said for 2018 Fossil would be a smaller company with a focus on profits and moving down a solid path for the future. Shares spiked 79% in afterhours to close at $16.31.


Twillo (TWLO) reported a loss of 3 cents that beat estimates for a loss of 6 cents. Revenue of $115 million beat estimates for $103.7 million. The company guided for a loss of 5-7 cents in Q1 on revenue of $115-$117 million. Analysts were expecting -5 cents and $108.2 million. Shares rose 6% in afterhours.


Walgreens Boots Alliance (WBA) is in talks to acquire AmerisourceBergen (ABC) according to the WSJ. WBA already owns 26% of ABC. Recently CVS inked a deal to acquire Aetna (AET) in what was seen as a preemptive move ahead of Amazon getting into the drug market. With WBA trying to acquire ABC it could set the stage for even more mergers in the space now that JP Morgan, Berkshire and Amazon have joined forces to create a nonprofit to lower healthcare costs for employees.

Walgreens tried to acquire Rite Aid (RAD) in 2017 but could not get regulatory approval and ended up buying less than half their stores. If the Amazon, Berkshire, JPM deal is the first big move to reduce prices across the board, companies like Walgreens will have to reduce costs and that is why they are targeting ABC. The company sources and distributes brand name and generic drugs in the US and internationally. ABC also offers pharmacy management and supply management software to retail and institutional healthcare providers as well as animal health care products.


Chipotle Mexican Grill (CMG) announced they were replacing founder Steve Ells as CEO with Taco bell CEO Brian Niccol. Ells had announced in November he was stepping down. Niccol said, "At Chipotle's core is delicious food, which I will look to pair up with consistently great customer experiences. I will also focus on dialing up Chipotle's cultural relevance through innovation in menu and digital communications." Apparently, investors were thrilled because shares rose 11% in afterhours. The Taco Bell CEO definitely moved up since the quality of the stores is significantly higher.




Markets

Tuesday was a wait and see market. Investors are waiting to see if there is going to be a retest of the market lows. They were nibbling on stocks but conviction was very low. Volume at 6.45 billion shares was the lowest since January 8th. After a week of 10-12 billion share days, this was positively anemic. Typically, there is a minor rebound from correction lows that can last several days to a week and then the second wave of selling hits and that appears to be what investors are watching.

The A/D line was positive 4:3 advancers over decliners but there was no excitement. As I showed earlier, the markets were dormant except for the opening drop and the 1:15 buy program. The indexes are testing prior support from late December, which has now become resistance.

The S&P gained 7 points with a high of 2,669 and just under resistance at 2,675. The index used the 100-day average at 2,642 as intraday support. The S&P needs to move over the 2,675 level, the psychological resistance at 2,700 and the 50-day average at 2,720 before investors will be comfortable with the rebound. Over the last two hours, the index traded just under Monday's intraday resistance at 2,667. There are definitely sellers waiting but they are not pushing prices lower. This is a lack of conviction on their part as well.


The Dow has tested corresponding resistance at 24,700 for the last two days. A move over that level faced 25,000 and the 50-day average at 25,118. The Dow is just one good day away from that 25,000 level. I was encouraged the -180 point dip at the open was recovered and the Dow closed with a gain even though it was 65 points under the intraday high. The Dow components were almost exactly matched between advancers and decliners. We need that ratio to swing a little further into the advancer column in the days ahead.



The big cap tech stocks were anemic as well with half of them posting losses or gains of less than $1. Facebook continues to be a drag due to regulatory issues. There are so many agencies and legislators taking aim at Facebook they are too numerous to list.

The Nasdaq never closed in correction territory under 6,755 and has already reclaimed the 7,000 level. The next hurdle will be the 50-day at 7,081. The Cisco and Applied Materials earnings on Wednesday should not impact the market materially. Cisco is a $41 stock and AMAT is $49. It would take major moves of several dollars to impact Thursday's market.



The small cap Russell 2000 is lagging the big cap indexes. The Russell only added 4 points and remains 13 points below decent resistance at 1,508. This suggests fund managers are not yet comfortable in putting money into the stocks with lower liquidity. They are still worried about market direction.


Unless the CPI report is explosive on Wednesday morning, I do not expect a major downward move in the market. If it is tame, we could see a decent rally on relief that interest rates are not going to spike suddenly.

Despite three days of gains, we could still see some market weakness. The -180 on the Dow this morning was an example. The ultra light volume could be related to option expiration where all the options were blown out last week. Maybe the low volume is related to a lack of remaining open interest in February options.

However, I believe it is just a symptom of the rebound from the correction. Traders are expecting the normal second dip and until either it arrives or the market moves up enough to remove those fears, we could continue to trade in baby steps. I would be a buyer of good stocks in small quantities and add to those positions if we get a second dip.

Enter passively, exit aggressively!

Jim Brown

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