The Nasdaq stretched its winning streak to 10 weeks, but the Dow, S&P and Russell are no longer in the race.
A better than expected economic report in China boosted the overnight S&P futures and a short squeeze was born. It was very short with no follow through and the Dow returned to zero very quickly. Dip buyers appeared and the index posted a decent gain. However, it was 6 points less than what was needed to extend its weekly winning streak.
The Nasdaq was a better performer with almost a 1% gain for the week despite some weakness in the big cap FAANG stocks.
The Nasdaq is up +20% from the Christmas lows but it still 10% below the 2018 highs. There is room to run if all the market factors turned positive.
The economic factor is one area of concern. For instance, the ISM Manufacturing Index for February came in at 54.2, down from 56.6 and below expectations for 55.9. That is the lowest level since November 2016. New orders declined from 58.2 to 55.5. Thirteen of 18 industries reported growth in new orders in February. Order backlogs rose from 50.3 to 52.3. Production declined from 60.5 to 54.8 and employment fell from 55.5 to 52.3.
According to analysts the ISM was impacted by the extremely cold weather in February. Customer inventories declined from 42.8 to 39.0 suggesting there will be future order growth. This is the lowest level for inventories since July.
Trade uncertainty remains a challenge for manufacturers. They do not want to load up on import inventories when tariffs may be removed in the near future. This is a direct impact for costs and profits, and they will wait until the last minute to place new component orders.
Consumer sentiment for February is still recovering from the impact of the government shutdown. The headline number rose from 91.2 to 93.8 but that was less than the initial reading at 95.5. The present conditions component was almost flat with a slight decline from 108.8 to 108.5 but the expectations component rose sharply from 79.9 to 84.4 now that the shutdown is over. The current conditions component averaged 114.5 in 2018.
Personal spending in December declined unexpectedly by -0.6% from a +0.3% rise in November. A decline was expected since retail sales for the period also slowed. This was the largest monthly decline since 2009. Offsetting the spending was a huge jump in the savings rate from 6.1% to 7.6%. Analysts believe the impending government shutdown with 800,000 workers, skewed the results. Obviously, those workers were not out spending every dime they had and were saving for an expected loss of pay. Recreational goods and vehicles saw the biggest decline at -3.0% followed by clothing and footwear at -2.4%.
The release was delayed a month because of the shutdown and that is also thought to have caused some problems in the data collection. Surveying consumers a month after the period and asking questions about spending and saving and you are probably going to get some incorrect answers.
The personal income report for December/January showed a -0.1% decline in consumer income. This is not surprising since 800,000 workers received no income in January. This was the first monthly decline in income since June 2017.
Both of these reports are to be ignored. The data is skewed by the shutdown and questionable at best.
Vehicle sales in February came in at a 16.6 million annualized rate, down only slightly from the 16.7 million rate in January. February is always a slow month for auto sales because of the weather and the lack of tax refunds. Sales pick up in March as the tax refunds begin to appear. This report should also be ignored.
The economic headlines over the last three days spiked the yield on the 10-year treasury from 2.63% to 2.755% and a 4-week high. Better than expected manufacturing data in China and multiple people in the administration talking about fantastic progress in the China trade talks, caused rates to rise. Friday's close was not much below the high for the year.
The strong Q4 GDP number caused a spike in the dollar over the last two days to close near the high for the week. Uncertainty over the trade negotiations caused the yuan to fall and dollar strengthen. The spike in the dollar helped push commodities lower.
This is payroll week with the ADP forecast at 195,000 and the nonfarm guesstimate at 180,000. Analysts have been missing these numbers by tens of thousands and anything close to 200,000 will be considered a success. On the nonfarm report the average for the last four months is right at 250,000. Employment is very strong and now that spring is just ahead the job numbers will rise as hiring for outdoor jobs accelerates.
The construction spending report will be ignored because it covers December and is a lagging number. The ISM nonmanufacturing for February is expected to rise slightly but after the drop in the manufacturing report, I am concerned we could see weakness here as well.
The Fed's Beige Book report on Wednesday should show there is no material decline in the economy. This is a detailed report of conditions in each of the Fed regions and should show continued expansion in most.
We are only two weeks out from another Fed meeting with the decision on March 20th. There is a 98.7% chance there will be no rate hike at that meeting according to the Fed funds futures.
The Brexit is now less than 30 days away. Parliament will get to vote again on March 12th on a plan for the exit. This plan is expected to look almost exactly like the plan that failed by a record 230 votes in January. If that vote fails, there will be a vote on the 13th to "crash out" of the EU with no plan in place and suffer the consequences. If that vote fails, there will be another vote on the 14th for a short-term extension of the Brexit date.
If the first two votes fail as expected it is almost a guarantee that the date will be extended. Crashing out of the EU would be extremely damaging to the British economy. However, the EU would also have to agree to extend the deadline. March is going to be a rough month for Thresa May.
If Britain ends up with a hard Brexit it will impact our market as well because of the severe economic disruptions in Europe.
The pace of earnings continues to slow but there are some big names reporting next week. SalesForce.com, Costco, Target, Dollar Tree and Ross Stores are the highlights.
With 484 S&P 500 companies already reported the earnings expectations are now 16.7% growth. Q4 revenue is expected to rise 5.1% with 69.2% of companies beating on earnings and 60.2% beating on revenue. For Q1 there has been 70 guidance warnings and 31 guidance upgrades. The current PE is 16.6. There are 10 S&P companies reporting this week.
The earnings estimate for Q1 has declined from 5.3% as of January 1st, 2018, 8.1% as of October 1st to -1.1% as of Friday's close. Q2 growth estimates are now 3.2%, Q3 2.9% and Q4 9.3% growth. The early quarters have huge comps of more than 20% in 2018 and that is proving to be a monster hurdle. ANY earnings growth in the first three quarters of 2019 would be positive given those huge comps.
There were several large headlines garnering attention on Friday. Lyft said it was going to launch its IPO and would trade under the symbol LYFT on the Nasdaq. By launching ahead of Uber, the company will get to control the perception of the ride hailing sector. Being the first they will not have to "measure up" to whatever metrics Uber discloses when they eventually file. That is good for Lyft because their metrics are terrible.
They disclosed they lost $911 million in 2018 on revenue of $2.2 billion. Hey, we are hemorrhaging cash, so we need to IPO quickly and raise more cash. Please buy our stock.
They are reporting "net" revenue rather than gross revenue. They took in $8.1 billion but paid out nearly $6 billion to drivers. The company considers itself an agent rather than an employer. Since both riders and drivers have the ability to reject a transaction price, it is up to the drivers to set the fare and that makes them contractors. Lyft is going to report gross revenue as "bookings" and that will allow analysts to calculate how much they pay to drivers. Lyft received $1.1 billion in revenue in 2017 and $343 million in 2016. They lost more than $680 million in both 2016 and 2017. Bookings rose from $4.6 billion in 2017 and $1.9 billion in 2016. Lyft said it had 39% of the ride share market in December, up from 22% in the year ago period. Part of the reason for the rising losses has been some heavy discounting with one program of 50% off your next 10 rides.
There is definitely a price war underway and if Lyft has grown market share from 22% to 39% that means Uber has been losing market share and that is not going to look good on their IPO. Lyft is going with a dual class share structure with founders Logan Green and John Zimmer retaining voting control.
This is going to be a very interesting IPO. They are attempting to raise $100 million despite their heavy losses. Give their $911 million loss in 2018 that $100 million is only about six weeks of operating capital. Then what happens? Their initial investors have probably cut off the cash flow and that is why the rush IPO. There is a good chance the IPO will crash and burn after the first several days of trading. They will have to post several quarters of decreasing losses before investors will be willing to own the stock long term.
Gap Stores (GPS) announced it was spinning off the Old Navy brand. This is a move investors have requested for years. Old Navy produced $8 billion in revenue in 2018 and all the other Gap brands together produced $9.1 billion. Old Navy will have no trouble supporting itself. Gap said, "the spinoff will enable each company to maximize focus and flexibility, align investments and incentives to meet its unique business needs and optimize its cost structure to deliver profitable growth."
The Gap, Athleta, Banana Republic, Intermix and Hill City brands will remain in the yet to be named company. Gap is struggling with same store sales falling 5% in Q4. They also announced they were closing 230 Gap stores (30%) over the next two years to "revitalize" the brand.
Despite the struggles the company reported earnings of 72 cents that beat estimates for 67 cents. What is Gap going to do when they don't have the profits from Old Navy to support them. This could be the mother of all short opportunities when the split appears. Buy Old Navy, short the new Gap stock. You will not get this opportunity until late in 2020 when the split finally occurs. Hangtime on the current spike is likely to be short. Put options are cheap.
Foot Locker (FL) reported earnings of $1.56 that beat estimates for $1.40. Revenue of $2.272 billion also beat estimates for $2.184 billion. Same store sales spiked 9.7% and double the 4.5% analysts expected. They opened 11 stores in the quarter and closed 56 stores. They now have 3,221 stores, mostly mall based. They are the only retailer to survive the decline in the American malls. However, they also announced plans to close another 165 stores.
One analyst said we are seeing a stealthy retail apocalypse. Over the last two days more than 465 store closings were announced. Gap is closing 230, JCP is closing 21, Victoria's Secret is closing 53 and Foot Locker 165. Business Insider said that would bring the announced store closing total for 2019 to more than 4,500.
Some of the previously announced closures include:
Charlotte Russe 94
Christopher & Banks 40
Beauty Brands 25
Henri Bendel 23
Cloud company Nutanix (NTNX) had a very bad day. The company reported a loss of 14 cents that beat estimates for a loss of 25 cents. Bookings of $413.4 million missed estimates for $416.5 million. The big problem came in their guidance. They guided for current quarter loss of 60 cents on bookings of $360-$370 million. Analysts were expecting 28 cents and $430 million. The CFO said the revenue decline was due to inadequate marketing spending and slower than expected sales hiring. Shares fell -33%.
Tesla's big announcement on Thursday caused a big decline on Friday. The company said it was finally going to make the $35,000 Model 3 as promised in April 2016. That is the good news. However, in order to remain profitable with only a $35,000 product, Elon Musk said they were closing all of their retail stores and would only take online orders. This will allow the company to reduce expenses while they produced the cheaper vehicles.
This concept comes with a lot of challenges. Some states/cities will not allow a car company to sell cars without a retail location while others have blocked the direct sales model without independent dealers. Musk did say some high traffic locations would remain open as showrooms, but sales would only be made online. This means there will be another round of layoffs and because it will take months to shutter the stores, Musk said Tesla would not be profitable in Q1. There is also the potential for many potential sales to not be made. Salespeople, currently "selling" the cars in typical salesman mode, will no longer be there and there may be quite a few sales that never occur because nobody is standing beside the customer talking them into the purchase.
The stripped-down Model 3 at $35,000 may not actually sell. Musk said they would have to poll the current reservation holders to see if they still had interest before they could offer the car to new purchasers. Since the Model 3s over the last year had been in the $55,000-$60,000 range fully loaded, expectations have been raised. Lowering those expectations to focus on a limited range, stripped down car may be difficult.
Tesla also announced price cuts on the Model S and Model X. The long-range vehicles cost around $96,000. Those prices were reduced to $83,000-$88,000. The long-range Model S costs $4,000 more than the base version and has 65 miles of additional range and is 15 mph faster. The Model S performance version was reduced from $112,000 to $99,000. The Model X performance version declined from $117,000 to $104,000. If you want to add Ludicrous mode to either version it is now $15,000, down from $20,000. That increases acceleration by 20%. Analysts were quick to blame slowing demand for the price cuts. With so many electric cars now available, the competition is rapidly increasing.
Another casualty of closing the retail locations will be the end of Solar City/Tesla Energy. Those locations currently sell the solar products and the battery backup systems for solar installations and areas with weak power grids. If they close those locations, the solar/battery business will die. At 2-3 times the cost of a generic solar system, Tesla Energy was almost dead already.
Tesla (Musk) paid $2.6 billion to rescue Solar City in 2016. The company has never thrived and continued to decline with Musk concentrating on the electric cars, giga-factories, the Boring Company and SpaceX. Last June he cancelled a deal with Home Depot, which was selling solar in their stores. The customer acquisition cost of a solar system sold through Home Depot was averaging about $7,500 per customer and made it nearly impossible to make a profit on a $25,000 solar installation. Tesla kept raising the prices on their solar products to compensate but sales slowed to nearly zero. In June Tesla closed about a dozen solar facilities.
A Tesla spokesman told Reuters on Friday they cut solar system prices in November by as much as 25% representing savings of up to $5,000 per system. In Q4, Tesla deployed 73 megawatts of systems, down 21% from Q3 and well below Solar City's 200 megawatts per quarter before being acquired by Tesla. In the 2018 annual report the company said the production of the much touted "solar shingles" had been delayed by production problems. In January Tesla said it was training their sales teams to sell solar as well as cars. Salespeople reported that Tesla branded panels had not even been available in the last half of 2018.
Short sellers were positively giddy on Friday. They believe the demand for Tesla vehicles is falling dramatically. They also believe the stripped down, range limited, $35,000 Model 3 will bomb and poison sentiment for the higher priced versions. Muddy Waters Research, CIO Carson Block, said all the bad decisions are simply confirmation Tesla will eventually go bankrupt. Musk is too distracted, demand is slowing, prices are falling, profits are shrinking, competition is increasing and the company itself is shrinking as evidenced by everything I listed above. This could be the beginning of the end. Shares fell $25 on the news.
The Apple shareholder meeting is history. CEO Tim Cook faced some heated questions about future products and company direction. Apple is not expected to have a 5G phone until Q4-2020 because of its current dependence on Intel for the modems. Intel is running about a year behind the other manufacturers. Meanwhile Qualcomm is signing up other manufacturers almost daily.
Apple claims it is in no rush because only about 20% of the US population will have 5G coverage by mid 2020. Globally, it will take a lot longer. However, Asia is expected to be on the leading edge of adoption. Analysts believe the delay in having a phone will mean users in early 5G areas will break with Apple and move to other devices like Samsung with the faster Qualcomm chips. This could force Apple to reduce prices on their Q4-2019 phones to maintain market share, which is currently 18.2% of all smartphone users.
However, when they eventually produce a 5G phone, nearly EVERY existing Apple customer will upgrade. Who does not want 50 times the download speed, instant app download, 30 second movie download, instant response to web browsing? This will be a major windfall for Apple in 2021. According to UBS there are more than 918 million active iPhones. If only 50% of those opted to upgrade in 2021 it would be a monster year for Apple.
Unfortunately, until Q4-2020 the outlook is boring. They will sell more airpods with currently more than 20 million in use. This has been a runaway success. They will have three cookie cutter iPhones in Q4-2019 but the Apple fan sites have already lost the excitement for the rumored models. Without a new must have feature, like 5G, they are just like the current phones with a few tweaks.
Shares are struggling at $175 with a very reasonable PE of 14. In theory, they should be a long term buy but few are buying. Even Warren Buffett with 250 million shares said he was not buying any more unless the price declined significantly. If you translate that statement it means he thinks the stock is either overpriced or fairly priced at this level given the recently lowered guidance by Apple. I suspect at $150 there would be no shortage of buyers.
Amazon (AMZN) is planning to open "dozens" of grocery stores across the US and they will not be Whole Foods. The first one will be in Los Angeles by the end of 2019. Reportedly, Amazon is looking for some small chains of about a dozen stores each to acquire and rapidly expand its footprint. Whole Foods has strict rules about artificial ingredients, organic foods, etc, and it is the highest priced of any chain store. Amazon is reportedly going to get down with their new chain and compete with places like Walmart, Kroger, Aldi, etc. Kroger has more than 2,000 stores and Walmart more than 6,600 in the USA. Walmart said their online sales would grow more than 35% in 2019. Target is taking on Amazon directly by announcing they were accepting private sellers for products on the Target+ retail site. That means sellers on Amazon can sell on Target as well and that is another threat to Amazon.
However, Amazon is the king of low margin retailing. They will be a major competitor for grocery retailers. They have learned the business with the Whole Foods acquisition and now Bezos is ready explode his lower cost model across the country.
Crude prices tested $58 a couple times over the last two weeks but could not hold it. WTI declined -$1.50 on Friday on the surging dollar and late reaction to the US production increase to 12.1 million bpd. Inventories declined -8.6 million barrels because of a sharp drop in imports. With OPEC cutting shipments to the US in order to influence prices, I would have expected WTI to be higher. Saudi Arabia is cutting another 500,000 bpd starting March 1st. Around the end of March we will see refinery utilization begin to climb and gasoline prices tend to peak around Memorial Day. This will lift crude prices.
Active rigs declined by -9 to 1,038 with a drop of 10 oil rigs. I do not expect to see a surge in rigs until the new Permian pipelines are completed. There is no reason to spend money drilling the wells if there is no pipeline capacity to ship the oil.
The last half of February was true to the historical trend. The Dow closed at 25,882 on expiration Friday and 26,027 this Friday for a whopping two week gain of 145 points. Trading was volatile but the peaks and valleys were minimal. The major indexes did not decline over the last two weeks, but they also made no forward progress.
The S&P has gained 11.8% in 2019 and that is the best start for any year since 1991. The Dow is up 11.6%, Nasdaq 14.5% and Russell 17.9% since the December 31st close. They are up even more if you count backwards to the December 26th low.
Unfortunately, all the major indexes are at critical resistance and it will be tough to produce a major breakout from here. The main reason is that the expectations for a China trade deal have already been priced into the market. When Larry Kudlow and Steve Mnuchin both praised the fantastic progress in the negotiations early in the week, the market barely moved. A couple months ago that would have produced a 400-point rally in the Dow. This is clear evidence the good news has already been discounted.
We will probably get a decent bounce on news an agreement has been signed but it is likely to be brief and be followed by profit taking. Once that event is behind us the focus will immediately return to the market fundamentals. Today, that means declining economics and negative earnings growth.
Since the Christmas bottom the S&P is up 19.5%, the Dow 19.9%, Nasdaq 22.7% and Russell 25.3%. That is two months and four days of gains. Most years don't see gains that big. With declining earnings growth, the odds are extremely high we are going to see some significant profit taking after the Chinese trade agreement and possibly ahead of it as cautious investors try to exit ahead of a sell the news event.
Also positive is the fact that analysts are expecting Q1 to be the trough in earnings with gains the rest of the year. They are not expecting big gains, but small gains are better than any loss. If we do get a China trade deal, the USMCA is approved by Congress and Britain has a peaceful and coordinated exit from the EU, the earnings estimates should rise along with the markets.
For the S&P the key level remains 2,815 and resistance from Oct/Nov. I believe if we can punch through that level on decent volume the next target will be the prior high at 2,930. This close to the old high that level becomes a self-fulfilling target. That does not mean we will simply blow through it to new highs because there is a better than 50:50 chance that it could turn out to be a double top.
The Dow missed extending its streak of gains to 10-weeks by 6 points. The index struggled for the week thanks to Apple, UnitedHealth, Home Depot and Walgreens. Baird added WBA to its "negative" list and shares fell 6% on Friday. Constant chatter about "Medicare for all" crashed the medical stocks and UnitedHealth shares fell -$25 in two days to knock roughly 175 points off the Dow.
If a trade deal appears in a couple weeks, we could see gains in CAT and MMM but even those tariff sensitive stocks have been struggling despite the positive news on negotiations.
We are right in the middle of the post earnings depression period and it will take some new headlines to lift us back to the highs.
The Nasdaq is holding right at resistance at 7,600 and has the best chance for a breakthrough. The next soft target would be 7,932 followed by 8,115. Two of the FANG stocks posted gains and two of them posted losses for the week. This kept the Nasdaq from advancing but the intraday dips were bought.
The Russell 2000 failed to decline materially for the week. The loss was only 0.42 of a point. The index is trapped between the 200 and 300 day averages and round number resistance at 1,600. I believe a breakout is imminent but until it happens, we are stuck at resistance.
I believe we are going higher simply because the China trade deal has not happened and there is still some hope for a miracle rally. Add to that the gravitational pull from the prior highs and that is prompting investors to put more money at risk. However, with roughly 20% gains since Christmas, there will be profit taking. The only question is where and when. Reaching the prior highs on a China trade agreement could be the starters gun on a meaningful decline.
Enter passively and exit aggressively!
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