The markets rebounded from the most oversold conditions since the 2008 financial crisis.

Weekly Statistics

Friday Statistics

The S&P fell -19.78% from the October high at 2,930 to a low at 2351.10 on Monday. The plunge took only 53 trading days and the index fell 16% in just the last 14 days. Markets were severely oversold as tax loss selling took control amid Fed fears and political anxiety.

Monday's low was caused by Treasury Secretary Mnuchin making highly inappropriate calls to the CEOs of the six biggest banks asking them if they had enough liquidity to weather the storm. This seemed to show a grossly unprepared Treasury Secretary that did not understand the banks are the most over capitalized in decades. They could easily weather a 50% market drop given their capital positions. The calls were probably made to show the administration was concerned about the impact of the market drop but had the opposite impact of causing the market to worry there was something we did not know and that the secretary was unqualified for the position.

The market declined the most ever for a Christmas Eve. When calmer heads came back to work on Wednesday the Dow posted its biggest gain ever at +1,086 points. The added benefit was the lack of tax loss selling. Portfolio managers sitting on piles of cash from the selling over the prior 60 days, suddenly went to work window dressing their portfolios for year end.

Friday's volatility was probably due to weekend event risk, profit taking from the big rebound and worries over the potential for a new wave of tax loss selling when January opens for business in a new tax year.

There is precedent for large declines in early January with the S&P falling -12.9% in 14 days in January 2016. The decline began on New Year's Eve and was nonstop until the bottom on January 20th. The massive losses in the market over the last two months has caused a significant change in tax planning for most portfolio managers. They were caught off guard and there could be a large number waiting for the new tax year to begin restructuring portfolios.

On the flip side, tax loss buying in January is market positive. Investors that sold in Nov/Dec are sitting on cash and waiting for the end of year volatility to fade and Q4 earnings to begin. There will be billions flowing back into the market in mid-January thanks to the big cash piles at year end. If we were to get an early dip next week, I would expect it to be bought.


Friday had some leftover economic reports that had been pushed later in the week from their normal times. The Pending Home Sales for November declined from 102.1 to 101.4. The index has now posted declines in six of the last eight months. This is the lowest level since mid-2014. Sales in the Midwest declined -2.3% and South -2.7%. Sales rose in the Northeast by 2.7% and West by 2.8%. On a trailing 12-month basis, the index is -7.7% below year ago levels. The South was pressured by a hangover from the hurricanes. The Midwest suffered from cold winter weather. Overall, despite a decline in treasury yields, the 30-year mortgage rates continue to hover around 5%. Home supply is another factor with available homes dropping to 3.9 months of sales in November. Many of those are the reject homes that have been on the market a long time. Any decent home with a reasonable price is snapped up quickly.

EIA oil inventories for the week ended Dec 21st, declined 100,000 barrels. This was different than the unexpected 6.9 million barrel gain in the API inventory report on Thursday. Inventories should be declining ahead of the December 31st property tax deadline, but the dip was minimal over the prior three weeks totaling only -9.0 million barrels. Refinery utilization declined only slightly from 95.4% to 95.1%. That is still 3.4% higher than the same week in 2017.

Saudi Arabia said it was cutting exports to the US in order to influence the price of WTI. Those cuts will show up in January. A sharp rise in US exports has lowered net imports by 2.0 mmbpd in December. Unfortunately for prices, US production is up about 2.0 mmbpd in 2018. This swells US inventories despite the rise in exports. This will increase in mid-2019 as additional pipelines from the Permian begin operation.

Oil prices closed on Monday at $42.68 and a level not seen since June 2017. Prices spiked on Wednesday to close at $46.25 for nearly a $4 gain but traded sideways the rest of the week to close at $45.11 on Friday. The path of prices should be higher in future months. With production cuts in January and the high demand months of Feb-June, we could see prices back over $60. I am going to hate that because I am loving buying gas at $1.90 at Costco in Denver. According to Gas Buddy prices are as low as $1.68 in the South near refinery country.


Natural gas inventories declined only 48 Bcf last week and only about a third the normal decline. Despite some winter storms the weather this fall has been relatively mild. Gas demand is very low and that is a good thing because gas supplies in inventory are at multi-year lows. They are 18.6% below 2017 levels and 19.2% below the five-year average. If we had a prolonged period of severe winter weather, we would be in trouble. New laws passed to prevent flaring at the well sites will increase gas production in the years ahead. However, the rapid completion of LNG export terminals is going to be a drag on inventories beginning in 2020.


This is payroll week with the ADP Employment, Challenger Employment report and the Nonfarm Payrolls. No material change is expected with new jobs in the 175,000-180,000 range. Fed Chairman Jerome Powell will speak on Friday and that could be the highlight for the week if he uses a more dovish tone. He has been a negative for the market for several months now.

The ISM Manufacturing Index on Thursday will be an important read on the national manufacturing sector.

There are no material earnings next week.


As you can imagine, with everyone going home early for the four-day weekend, there was very little stock news or news of any kind. Unfortunately, Apple was still being downgraded.

Citigroup slashed production estimates on the XS Max, the most expensive phone. They cut overall iPhone production estimates from 50 million to 45 million. They said they cut XS Max estimates by 48% but did not give the numbers. The analyst said Apple was entering a "destocking phase" where a buildup of unsold phones would have to be eliminated in Q1. The analyst warned that Apple could not continue to scale up their average selling price because the number of people able to pay more than $1,000 for a phone was shrinking.

There are 4 billion cell phones on the planet with 1.5 billion expected to be sold in 2018. With the average age of phone replacements rising to more than 3 years and as much as 4 years on the more expensive models, the analyst was talking "peak" smartphone sales.

Taking a different view was Davidson with a buy rating on Apple. The company said Foxconn will begin assembling iPhones in India in 2019 and that will be a booming business without the import tariffs. Apple already makes the lower priced SE and 6S in India. The analyst said Foxconn was spending $350 million to upgrade a plant in Sriperumbudur in Southern India. They are also planning a plant in Vietnam. It is unknown if they are going to manufacture phones for export and how much of production would be moved out of China to avoid tariffs. Foxconn manufacturers about 50% of all iPhones in a plant near Zhengzhou China. Davidson has a buy rating and $280 price target.


Dell Technologies (DELL) returned to the public marketplace on Friday when it began trading under the symbol DELL. Previously, Dell was traded through a tracking stock (DVMT) on WMWare. Dell owned 80% of VMWare. They bought out their interest in the VMWare tracking stock for $23.9 billion and changed the ticker to DELL and that is now a pure play on Dell. The company did not want to go through the process of a road show and public offering because they have $52.7 billion in debt. That would have depressed any IPO price. Shares of DVMT ceased trading on Thursday at $79.75 and shares of DELL opened for trading on Friday at $46.00. They are likely to remain volatile until they report earnings for Q4 and investors see the full picture. JPM was the first to rate Dell giving it an overweight rating and $60 price target.


Tesla (TSLA) named Larry Ellison and Kathleen-Wilson Thompson to the board of directors. This was a major win for Elon Musk. He has been pressured to expand the board because of his erratic behavior. The SEC felt the board needed to have more control. Larry Ellison (ORCL) is a good friend of Musk and a large investor in Tesla. The odds of him censuring Musk for something are very slim. That is like adding a Musk clone to the board and a stealth play to evade the SEC's plan for more control.

Thompson is the global head of human resources at Walgreens Boots Alliance (WBA) and has a passion for sustainable energy.


Xanthic Biopharma (Green Growth Brands) made an unsolicited bid for $2.1 billion to acquire Canadian cannabis company Aphria Inc (APHA). Aphria said the bid significantly undervalued the company and the offering was risky since it required a brokered financing package at more than double the current share price.

The key point in this sector is that there are 30+ companies and there will be a significant amount of consolidation. The field is so broad and so new that it is tough to know which ones are going to be winners and which will cease to exist. The US is moving slowly towards legalization of cannabis and that is the pot of gold at the end of the rainbow for these companies. They just need to hang on and refine their processes until the US market arrives.


Salesforce.com (CRM) rebounded about $15 since Monday and the acquisition rumor mill is alive and well. About once a year we hear that either Microsoft, IBM, Oracle or Google is about to buy the company. So far, those rumors have not come true but that does not mean it will not happen. Salesforce and Microsoft compete in the same CRM space, but Salesforce has twice the market share of Microsoft. They are strategic partners in the Microsoft cloud but still competitors. Salesforce has a market cap of $103 billion and could easily be acquired by Microsoft if they could get regulators to approve the deal. A combination with Microsoft would give them about a 23% share of the CRM market.

IBM is rapidly trying to improve their cloud offerings and acquiring Red Hat to expand their presence. They are not really competitors and regulatory approval would not be a problem. This would be a great move by IBM but there could be a bidding war with Microsoft. An acquisition by IBM would give them about 20% of the CRM market. Unfortunately, IBM is light on cash and has $35 billion in debt. That could hamper the financial solutions.

Oracle would seem like a perfect fit since the Salesforce CRM product runs on an Oracle database. However, there are tons of conflicts and it would be tough getting regulatory approval.

Google is not really a player in this space and is not really a potential acquirer.

Just keep the rumors coming and the stock rising, and I will be happy.


Netflix (NFLX) said that more than 45 million accounts watched the new movie "Bird Box" in the first seven days of release. Since in many cases more than one person watched the movie and there is widespread sharing of accounts, as many as 75 million people could have watched the Sci-Fi movie starring Sandra Bullock. That is more people than watched some Harry Potter films.

Netflix said it had 137.1 million accounts at the end of the last quarter. That means more than one-third of the accounts had watched the film. The company had planned to release 80 films in 2018 with budgets up to $200 million each and 90 new films in 2019 with a total budget of as much as $13 billion. To put that in perspective they only released 8 films in 2016.

Shares have been crushed since the July high at $419 to close Friday at $255.48. Shares are up $25 since Monday's low.


Sears Holdings (SHLDQ) came close to liquidation on Friday but won a reprieve after Chairman Lampert made a last minute $4.4 billion bid for the bankrupt company. The offer came just before the 4:PM deadline from the court. The offer is for 425 of Sear's 700 stores and would provide employment for 50,000 Sears employees. The company's advisors have until Jan 4th to decide if ESL is a qualified bidder. Many of the creditors do not want Lampert to get the bid. They are hostile for what they have seen as a slow decline for the years he was CEO. If they decide to accept him as a bidder, he can then submit his bid in competition with the liquidation plans on January 14th. Multiple firms have submitted offers to liquidate the company and what they expect to get from the bankruptcy sale. Sears already owes Lampert $2.4 billion for loans he made to keep the company running over the last several years. The other creditors are objecting to Lampert submitting a bid where he "forgives" that debt as part of his payment for the company. They want real money in cash for the $4.4 billion.

On October 15th Sears filed for bankruptcy and said it would close 142 unprofitable stores. In November it announced closing of another 40 stores. On Friday the company announced the planed closing of another 80 stores. That total is 262 of the company's 700 stores on October 15th. They currently employ 68,000 workers.

Sears was founded in 1893. In 2006 the chain had more than 3,500 stores and more than 355,000 employees. At one time it was the largest retailer in the US and the Sears catalog or "Wish Book" was delivered to every home in America. When Sears failed to move to an online marketing retailer to compete with Amazon and others, its fate was sealed.




 

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Markets

The S&P plunged on Monday to close at 2351.10 a drop of 579.65 points and -19.78% below the September 20th high close at 2930.75. Technically the long running bull market is still alive by the smallest of margins of 6.45 points. The rebound was impressive with Friday's intraday high of 2,520, a 169-point recovery from Monday's low close. However, the market was the most oversold since the financial crisis and it was due for a monster bounce.

The critical piece of the puzzle is what comes next. The Dow and S&P are on track for their worst December since 1931. That suggests we should see a continued rebound in January but not necessarily straight up.

Over the last 13 bear markets with a 20% decline or more in the S&P, the market continued an average of 8% lower after reaching that 20% mark. Just because we missed it by 6.44 points does not mean we are not in a bear market. That is close enough.

The average rebound after a bear market low is 14% in the year that follows.

Looking back, we can easily spot the causes of the decline and decide how much impact those events will have on the rebound. The biggest problem was the Fed's hawkish language over the last two months and the Powell claim that the Quantitative Tightening (QT) was on "autopilot" for another $600 billion in 2019 and the equivalent of three additional rate hikes. Powell also said the Fed was planning on two regular hikes in 2019. That sent the market into a dive.

Adding to the problem was the constant twitter attacks on Powell by the president. In addition, the resignation of Mattis, the impending government shutdown and Mnuchin's calls to the banks all weighed on market sentiment.

The only one of those events likely to continue to be a cloud over the market is Fedspeak. Until Powell lightens up on the rhetoric there will be continued worries.

The government shutdown, Mattis termination, Syria pull out, Mnuchin, etc, are now old news. They should have no further impact.

The sharp sell off in December caused further selling. As I have said many times selling begets selling. The severity of the losses caused a strong wave of tax loss selling in a short period of time that pushed the market to its lows. That is now over.

There may be another cycle in early January as those holdouts waiting for the arrival of a new tax year decide to take their losses. For one reason or another they held off taking additional losses in 2018 and will hit the sell button in early 2019. These should be brief, and any dip should be bought.

There are billions of dollars sitting in accounts of portfolio managers as a result of the tax loss selling and stop losses getting hit in the crash. They will want to put that money back to work as early in January as possible in order to profit from any earnings generated rebound and the current low stock prices.

As companies begin reporting earnings on January 14th, they will also be announcing new stock buyback programs. With equity prices so low they can get more bang for their buck with an accelerated program. That will also serve to lift the market.

Once it is clear the bottom is behind us the cautious investors will begin to come back into the market. That could provide the longer-term uptrend we are expecting for Q1.

I was with a high net worth investor on Christmas Eve. After that drop he called his broker and moved 50% of his assets to cash. I thanked him for his capitulation because it probably meant a large number of likeminded investors did the same thing. That typically signals the bottom in the market .

The S&P fell 16% since December 3rd or -449 points. In any normal rebound a 25-38% retracement should be expected before profit taking begins again and we face the potential for another decline. The intraday high on Friday came within 0.44 points of a dead stop on that Fib retracement level. This is exactly where it should have stopped.

In a normal chart not influenced by EOY calendar implications, we should expect a minor retracement of some of those gains. We could get that from any early January tax loss selling. In a normal market we could also expect a retest of the lows. I believe the calendar issues will prevent that complete retest although we could see some early January weakness.



The Dow rose to +243 intraday and the low was -155. The high came around 2:30 and sellers appeared just before the close. It could have been profit taking, weekend event risk or simply closing the books for the year.

The Dow rebounded 1,340 points from Monday's low with the biggest single day gain ever at 1,086 points on Wednesday. There are multiple short-term resistance levels at 23,500, 24,150 and 24,800. The range on Friday had a little something for everyone and volume was strong at 8.1 billion shares. Advancers were almost 2:1 over decliners. Dow stocks were a little worse, but the losses were minimal. Friday was a pause to reflect after the rebound smoke cleared.



The Nasdaq rebounded almost 400 points from the low and came to a dead stop 2 points below the Fib retracement level at 6,686. For it to stop at the same relative level as the S&P is not a coincidence. Technical analysis does matter, and it is used in trading.

Google was the biggest loser of the big caps and Tesla the biggest winner. Amazon has been a leader after they bragged of a record holiday season. Amazon said "tens of millions" customers started new Prime subscriptions. They shipped more than one billion items with free shipping on Prime. Shares rose 205 points from Monday's low to Friday's high.



The Nasdaq is still very oversold and could easily rally 1,000 points and only reach December's high at 7,486. It could be a long time before we see the old August highs retested again.


The Russell remains in a bear market and did not come close to the same relative Fib level at 1,375. Small caps are trying but they do not have any investor confidence at this point. They are still in a downtrend until the index moves well above 1,500.


To summarize my earlier comments, we could see some early January weakness, but I would expect it to be brief. Earnings begin in two weeks and they are expected to be good. Companies will be updating guidance for 2019 and announcing additional stock buybacks. I would look to buy any early January dips.

PUBLISHING SCHEDULE: Because New Years is on a Tuesday, we will NOT publish any newsletters on Dec 31st. I am sure you will agree that nobody will be paying attention to the market on New Year's Eve. This is the equivalent of a four-day weekend. Thank you for your understanding.

Enter passively and exit aggressively!

Jim Brown

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