The Dow Jones Industrial Average has extended the 2019 rally to a ninth week, with trade-optimism rising the tenth week of gains is not out of the question. If not for trade, this week's big news would have been the FOMC but as it is, trade trumps all (pun intended).

The minutes were more or less as expected but with some twists that took a day or two to digest. The majority opinion is that pausing the rate hike cycle poses little risk and that benefits are many. Patience remains the main buzzword but that is offset by mixed sentiment concerning future hikes. Many of the members favor additional rate hikes, expect the need for additional rate hikes, despite overshadowing risks. They didn't give an explicit outlook for the future because it's too hard to call. Trade relations with China are clouding the picture with a wide variety of potential outcomes.

Market Statistics

The most surprising news from the Fed's discussion is that they favor an end to QT rather than a tapering off. The discussion now is that they will end the balance run-off sometime in the second half of the year with an intention of providing more clarity on the path of interest rates. Regardless, the FOMC maintains a stance of 'flexibility' which means their plans will change with the conditions.

Jerome Powell will get another chance to make the FOMC's case and intentions clear this week. He is scheduled to appear in his annual testimony to Congress beginning on Friday. As of now, the CBOE's FedWatch Tool is a bit mixed. The odds of a change in rate policy is growing but it's a 50/50 bet as to which way the change will be in the first half of the year. Farther out, looking toward December, the odds of a rate change this year are still only 12% but heavily skewed toward a cut.

Trade relations are on the upswing and gaining momentum. After a week of lower and higher-level talks, Secretary of the Treasury Steve Mnuchin announced they would extend the talks two more days. The news is welcome and reinforces earlier reports the two sides were working on a framework of understanding for handling the most delicate issues.

Both sides seem to be in agreement. Both Trump and Xi have made statements to the effect we're making a lot of progress and a deal is very likely. Xi says both sides should redouble their efforts to meet halfway so there may be more progress this week.

Earlier this week I described two possible outcomes for the trade negotiations, deal or no deal, with global economic growth hanging in the balance. There is a third possible outcome, one in which the current tariff environment remains intact and global growth progresses at the 3.5 to 3.6% rate projected. Regardless of the outcome, trade is going to be an important topic in the coming week.

This week's economic calendar includes the 1st and 2nd estimate for 4th quarter GDP. The consensus estimate for the estimate is 2.0% and may miss considering the slowdown in activity that occurred the last two months of the year. The Atlanta Fed's GDPNow tool took a sharp downturn in the last update and now points to only 1.5% GDP growth for the 4th quarter. The good news is that GDP is expected to rebound to an average 2.4% in 2019; the bad news is that we've had some weak data over the last week that may drag that estimate down.

The Economy

Last week's economic data was not great. It wasn't particularly bad but it does point to slowing activity most likely due to US/China trade relations. On the labor front, jobless claims and labor data within the Philly Fed MBOS and Markit PMI readings show labor markets remain strong. The number of jobless claims is receding from their post-holiday highs and hiring is still expanding. On the manufacturing front, the MBOS came in below 0 showing contraction of overall activity despite an increase in hiring. Assuming the economy is still stable, this means manufacturers are expecting activity to pick up again else they wouldn't be hiring. If not I expect labor data to start deteriorating soon (but I don't expect that).

Next week's economic calendar is a full one, and not just full, stuffed. The regular lineup includes, in many cases, two batches of data as agencies catch-up following the government shutdown. Needless to say, there will be a lot for the market to sift through. Housing data dominates the list early in the week but most of it is old, December or January. Later in the week, the first and second estimates for GDP is on Thursday but the big report will be Friday. Friday we get not one but two months of Personal Income and Spending, and two months of PCE Prices which come out smack in the middle of Powell's two-day testimony. Based on the other data points I've seen I expect income is up, spending is flat, and inflation is down.

The fourth quarter earnings cycle is all but over. There are now 89% of S&p 500 reports in the bag. The reports are generally better than expected but the number of companies beating estimates, the rate at which companies are beating the consensus, and the number of sectors beating estimates are all below average. The blended rate of earnings growth for the quarter is 13.1%, down a bit over the last week, but still double digits.

The problem is that the outlook for future quarters continues to decline. All four quarters of 2019 saw downward revision over the last month and that is likely to happen again as the final 10% of the S&P 500 report their results and provide their outlook.

The worst part is that first-quarter earnings outlook is now negative. This is due in part to the one-off impact of last year's tax-reform but also to narrowing margins. Margins are expected to shrink in 10 of 11 sectors but that is mitigated by the outlook for margin expansion. Margins are expected to begin widening in the 2nd quarter of 2019 and continue expanding through the end of the year.

The first quarter's earnings cycle is going to be bad, but it probably won't be as bad as expected. If the cycle produces a sell-off or bear market it will most likely be short-lived and result in a buying opportunity. Earnings growth turns negative in the first quarter but will (is expected to) turn positive in the 2nd and accelerate over the next 4 to 6 quarters. Not only that, earnings growth is expected to re-accelerate to double digits by the first quarter of 2020 and estimates for 20202 are on the rise. It's still early to call but this is setting us up for a nice rally in the second half of this year if not sooner.

There are 39 S&P 500 companies scheduled to report this week including 1 Dow component. That is just about 10% of the index and will put the lid on the season save for a lone straggler or two.

In The News, Story Stocks and Earnings

Kraft-Heinz reported earnings on Thursday and set the tone for next week's round of reports. There are several big-name food products companies on the list including Campbells, Smuckers, and Dean Foods and they all may post weaker than expected results.

Kraft reported revenue grew 0.70% over the past year but missed estimates and delivered some other bad news. The company had to write down $15 billion in valuation for previous acquisitions. The company also revealed an SEC probe into its accounting practices. Kraft also suffered a $25 million increase to the cost of items sold due to an internal review of said practices. Shares of Kraft Heinz fell -28% on the news, aided by a reduction to the dividend. The dividend was cut -36% but still a substantial 4.5% at current share prices so we may see some buying in the near-term. Looking at the bigger picture, packaged foods has been in a serious downtrend for many years as consumer shift away from salty, preservative laden boxed/bagged/canned/frozen dinners in favor of fresher and/or lower cost items. This, along with Kraft Heinz overleveraged balance sheet, will keep this stock under pressure longer-term.

Berkshire Hathaway took a big hit on the Kraft news. The companies holdings in Kraft shrank by nearly $3 billion in a matter of minutes following the release. Shares of BRKHA and B were both down in Friday trading but likely to rebound next week. The company just released earnings and Warren Buffet's annual letter to shareholders and the news looks good. Berkshire's operating income rose 71% in the last year to $5.72 billion on strength in Insurance-Investment Income, lower insurance write-offs, strength in Railroad, Energy, and Utilities, and strength in Other business.

In his letter, the Oracle of Omaha says its time for a change. He is no longer going to begin his annual review with references to book value because they are no longer relevant to the company. Now that Berkshire's value is centered in operating businesses and not so much in marketable securities it makes more sense to track performance via stock price. Another reason is that Berkshire will be buying back its own stock in the future at prices above book value so it doesn't really matter anyway.

Intel was a leader this week following an upgrade from Morgan Stanley. The analysts think the company can be rerated at a higher valuation with a more financially-oriented CEO. Morgan Stanley upgraded the stock to Overweight from Equal Weight with a price target of $64, a 20% increase. Intel followed up this good news with news of its own, providing an update on when its 5G chips would hit the market. The chips are now expected out in mid-2020 which coincides with the expected launch of Apples 5G iPhones late next year. Shares surged more than 2.0% on Friday and are now trading at an eight-month high.

The Semiconductor Index continues to be a market leader. The index only gained about 1.0% over the last week but is at a new closing high. While bullish, the index is also facing stiff resistance if not soon, then at the 1,400 level where price action was halted several times last year. The indicators are bullish but divergent on the daily charts and nearing overbought conditions on both the daily and weekly charts so caution is warranted. The outlook for semiconductor revenue in 2019 is on the weak side so there is a reason to suspect a pullback in prices is coming, longer-term however outlook for the sector is bright so any pullback would be a buying opp.

The FAANG group had a mixed week along with the rest of the market but, like the rest of the market, had a good Friday ending the week on an up note. As a group, the stocks appear to be consolidating after a nice run up at the beginning of the year. The consolidation has a bullish bias to it and may lead to an extended rally for tech and the broader market. Netflix is in the lead, posting a new four-month high during the week and closing high on Friday, but the technical picture is dim. The MACD and stochastic are both divergent and bearish which points to one thing, a weak market. A pullback in prices may bring this stock back to $340 or $320 in the near to short-term. It'll be two months before we get the next earnings report, a lot of time for the market to fret over subscriptions, cash-burn, and competition.

The Indices

There was a lot of churn in this weeks market but the indices were able to move higher, the uptrend is still intact. The question now is, can the market move up for one more week? The answer is yes but depends on trade talks, the data, and nerve. How nervy is the market and will it be willing to hold on to stocks another week, or is it time to start taking profits?

The S&P 500 advanced 0.64% to close the week out near the top of the 5-day range. The index is creeping above my long-term uptrend line and may go higher but there is some risk. The indicators are bullish but momentum is highly divergent and prices are overbought so a pullback is needed for the rally to continue, if not due. Also, just above Friday's close, is the 2,800 market. This psychological round number may provide heavy resistance as it did in the October/December 2018 period.

Resistance at 2,800 is easier to see on the weekly charts. The line is consistent with the top of a very wide congestion band that eventually sent prices down to their lows in late December. Momentum is still rising on this chart, and stochastic has plenty of room to run, so I would expect to see 2,800 tested. It is the result of that test that will spell out the market direction for the near-term. If resistance is confirmed here tests of support at 2,700 and 2,800 are very likely as we progress toward and into the 1st quarter 2019 earnings cycle.

The NASDAQ Composite advanced 0.90% on Friday to push through the 7,500 level and set a new high. The index is moving higher on a wave of bullishness but that wave may soon run its course. The MACD momentum continues to weaken and diverge from rising prices and suggests a pullback in prices or test for support is inevitable. That being said, prices could rise for some time and the pullback could be small or large, it just depends on the market. For now, the index is facing potential resistance at the 7,570 and 7,660 levels that may cap gains in the near-term. A fall from this level would probably find support at the long-term moving average.

The weekly chart shows the same picture for the NASDAQ Composite. The near-term outlook is bullish but technical signals lead me to believe a retest of support is coming, probably before or coincident with the first quarter earnings cycle. The signal is this; the bearish MACD peak formed in December is an extreme peak, there are no others that strong for many years. This peak suggests that a major shift in underlying market dynamics is underway, something akin to a secular consolidation and stock market rotation, and a high probability the December lows will be retested before the rotation is over.

The Dow Jones Industrial Average advanced 0.70% on Friday and set a new high. The blue-chip index is moving up from support at a long-term uptrend line and looks like it could go higher. The moving averages have formed a bullish crossover and that is supported by MACD and stochastic although there are some red flags. Primarily, MACD and stochastic are showing divergent, overbought conditions ripe for reversal. If the index does move lower and support is not found in the range of 25,500 to 25,750 a deeper move, possibly to 25,000 or 24,000, is likely.

The weekly chart shows the blue-chip index trading right at a potentially strong resistance level. This level is just above 26,000 and coincident with the November/December highs set last year. The indicators are bullish so a test of this level is likely, a break above it is possible, with a possible target as high as the all-time high.

The Dow Jones Transportation Average posted the only decline on Friday, about -0.37%, after posting a much larger loss intraday. This move is concerning for two reasons including the transports tendency to lead the market and growing signs of weakness in the broader markets. The candle formed is a Dark Cloud Cover but mitigated by the visible lower shadow which reveals buyers were ready to buy when prices fell. The indicators are consistent with a peak, consolidation, and possible reversal in prices so I would expect to see sideways movement at least. A move lower may find support at Friday's low, a move below there could take the index down to 10,300 and the long-term moving average.

The transports were able to create a green candle this week and close at a new closing higher but the candle is small and has an upper shadow indicative of resistance. The index isn't so much at a resistance line as it is trading in the middle of a highly contested congestion band that dates to the October/December 2018 time frame so possibly strong. The indicators are bullish so upward price movement is still indicated although I might wait for a better signal on the daily charts before putting my money down.

The indices moved up for a ninth week and look like they might move up for a tenth. The move is supported by rising trade hopes but disconnected from earnings fundamentals so there is some risk in the move. The market may continue to move higher as the trade-talks progress but, once we clear this hurdle (assuming we clear the hurdle) and the market refocuses on earnings I think we will see profit taking set in. I hate to call tops because they never unfold the way I think but I am calling the possibility of a top and urging caution for the next week. I remain firmly bullish for the long-term, neutral and patiently waiting in the near-term.

Until then, remember the trend!

Thomas Hughes