The normal sell in May trend was active in 2019 but was driven by outside events not normal profit taking.

It has been a bad five weeks for the Dow with a combined decline of -1,722 points. That is a -6.9% decline since the April 23rd close at 26,656. I added the fourth week to the graphic below. The May 3rd week only lost 32 points. This is the Dow's longest consecutive losing streak since 2011.

Weekly Statistics

Friday Statistics

The new tariffs on Mexico were a bolt of lightning from a clear sky as nobody even remotely considered that a possibility. Only two days before the USMCA replacement for NAFTA was fast tracked and all was right with the world at least in North America. The lightning strike disrupted an already weak market and caused a -1.5% drop in the indexes on the last day in May. For the week the markets lost 2.5-3.0%. For the month the Dow lost -6.7%, S&P -6.6%, Nasdaq -7.9% and the Russell lost -7.9%.

An average year has two declines of 5% or more. Normally when May is down hard, June sees a decent rebound. This is not a normal year or a normal market. We are always just one tweet away from a massive short squeeze or a market crash. The Mexican tariff tweet was a prime example.

Some analysts are saying the coast could be clear for a rebound because the worst news is over. I disagree. China is going to lay out their trade claims in a white paper on Sunday and officials will take questions. This is unheard of in China where information is tightly controlled. This suggests there could be some blockbuster points in the release and signs of a government position that is even more resolute in not giving in to US demands. China has likely made the decision to try and wait for the US elections in hopes there is a new president in 2020. The eighteen month wait would be painful but the results of dealing with a democrat president would be preferable than what they are facing now.

The market is not immune to these bolts from the blue and there will always be a knee jerk reaction. Eventually after enough hits, investors will become vaccinated and they will welcome the dips to buy. Unfortunately, we are not there yet.

We are reaching levels where we should see a response from fund managers and technical traders. The 2,750 level is the year end target for multiple analysts and a level that is considered fairly valued for the S&P. A break below that level becomes a buying opportunity and that increases as we approach 2,625, which would be a strong buy zone.

Needless to say, the potential test of 2,750 next week is going to be critical. Given the recent decline and now oversold conditions, there is a good chance for at least a short-term bounce. We hope it works out better than the similar bounce from 2,800.


Friday was a good day for economic reports. The final consumer sentiment revision for May declined slightly from the first reading at 102.4 to a flat 100. That is still a great number. Analysts believe the flare up in the trade war with China was responsible for the minor decline. In early May everyone was expecting a deal to be imminent.

The present conditions component declined from 112.3 to 110.0 and the expectations component rose from 87.4 to 93.5 and a 15-year high. The strong job market and surging wage growth is responsible in part for the strong sentiment.


Personal income for April rose +0.5% and the second largest gain in a year. Analysts were only expecting a 0.3% rise. Wages and salaries rose 0.3% after a 0.4% gain in March. Wages are up 1.8% over just the last six months. Disposable income is up 3.8% over the last 12 months.

Personal spending was flat after a +0.7% rise in March. Spending on durable goods declined -0.4% and nondurable goods spending rose +0.3% with a -0.1% decline in services spending. The recent decline in gasoline prices is a good sign because it means once consumers believe fuel prices are stable at lower levels, they will spend that money on goods of some form. The savings rate rose slightly from 6.1% to 6.2%.

Continued blows to consumer sentiment will also cause a slowdown in consumer spending.

The Fed's preferred measure of inflation, the PCE Deflator, rose +0.3% after a +0.2% rise in March. On a trailing 12-month basis the PCE is showing only 1.5% inflation with the CORE PCE rising 1.6%. Durable goods inflation declined -0.4% and the third consecutive monthly decline.

The tame inflation and weak economic numbers in some areas suggests the next Fed move is going to be a rate cut. The consensus is now for two rate cuts before year end. There is a 96.2% chance of one cut and 79% chance of two cuts according to the Fed funds futures. The bar with the blue checkering is the current rate.


The various geopolitical issues and global economic weakness has pushed yields lower around the world. The US 10-year yield fell to a 21-month low at 2.14% on Friday. The Spanish ten-year yield fell to 0.718% and the London Gilt fell to 0.888%. The German Bund is negative at -0.207%. Around the world there is more than $7 trillion in sovereign debt with negative yields. That is not a sign of a rebounding global economy.


We have a busy economic calendar for next week with multiple payroll reports and two ISM reports. Despite the jobs blowout last month with 275,000 jobs on ADP and 263,000 on the Nonfarm report, the estimates are still hovering in the 175,000-180,000 area. Analysts are not going out on a limb with their forecasts.

The ISM numbers are expected to be flat but still in expansion territory. Construction spending should improve but factory orders are expected to decline due to uncertainty about the trade issues.

The Fed Beige Book comes out two weeks before the FOMC meeting. It is produced by a different Fed region each time and contains the anecdotal evidence of business activity in each of the 12 Fed regions. They could contain some weakness based on a slowdown in home prices and sales and declines in auto manufacturing.


The Mexican tariff news crushed the automakers, auto parts companies, truckers, railroads and even the consumer products companies like Colgate, Procter and Gamble and beer distributors including Constellation Brands. Chipotle Mexican Grill (CMG) lost $18 because the cost of avocados just went up.


Automakers were the hardest hit. The top four manufacturers build more than 625,000 cars a year in Mexico and import them back into the USA. Even worse for them, they have parts and assemblies that cross the border as many as 7 times during the manufacturing process. At 5% each time they move back into the US, that could get very expensive.


Mexico is a top trading partner. We import $93 billion in vehicles, $26 billion in agricultural products, $64 billion in computer products, $63 billion in machinery, $60 billion in auto parts and $16 billion in oil and gas. An extended tariff implementation will be painful for the US consumer. Contrary to White House claims, the tariffs are paid by importers, not the Mexican government. Those importers will pass those costs on to US consumers.

What it does do is incentivize importers to look for alternate sources of supply. If they think the tariffs are going to be lasting, they can move their manufacturing facilities. Pepsi just announced a couple weeks ago they were going to build a $4 billion facility in Mexico. I wonder if they are rethinking that this weekend.

The Mexican Peso was crushed on the news. Mexico lives off the money they receive from manufacturing goods to be sold in America. If this tariff program did ratchet up to 25% as proposed it would eventually cause serious problems for the Mexican economy.


The earnings cycle is nearly over. We only have a few recognizable companies reporting next week. Salesforce.com is on Tuesday and Beyond Meat will report their first earnings as a public company on Thursday.

Ciena, Zoom, Five Below, Gamestop, Ambarella and Box are the supporting cast.

We have seen 491 S&P companies report earnings with an expected final growth rate of 1.5% and 5.6% revenue growth. Of those reported, 75.2% beat on earnings and 57.1% have beaten on revenue. There have been 71 guidance warnings for Q2 and 22 guidance upgrades. Because of the market decline the forward PE has fallen to 16.3 for the S&P. Only 5 S&P companies are reporting earnings this coming week.


Companies reacting from earnings on Friday included Costco (COST) which reported earnings of $2.05 that easily beat estimates for $1.83. Revenue rose 7.4% to $34.7 billion and matched estimates. Same store sales rose 5.5% compared to 4.9% estimates. E-commerce sales rose 22%. This was a good report, but Costco shares were declining on Friday along with the market.

Costco is planning an ambitious path of store openings in China and the recent flare up of tensions could squash those plans. Costco is also at risk for higher prices from the Mexican tariffs, so shares fell $8 on the news but quickly rebounded to recover most of the loss. Analysts believe Costco is preparing to announce a special dividend.


Dell Technologies (DELL) reported earnings of $1.45 that beat estimates for $1.19. Revenue of $21.91 billion missed estimates for $22.6 billion. Results rose because of the Windows 10 refresh continues to power PC sales to businesses. Unfortunately, demand for servers and networking equipment declined. Revenue in the infrastructure solutions group declined -5% and networking revenue fell -9%. A 13% rise in commercial revenue offset a 10% decline in consumer revenue. They ended the quarter with $9.8 billion in cash.

Dell was hammered on Friday because they manufacture computers and computer equipment in Mexico. They actually moved some production from China to Mexico over the last year to escape the China trade war. Shares fell more than 10% on the news.


Dell subsidiary VMWare (VMW) reported earnings of $1.32 that beat estimates for $1.27. Revenue of $2.27 billion rose 13% and beat estimates for $2.24 billion. License revenue rose 12%. Total revenues, including unearned, rose 25%. They guided for the full year for revenue of $10.03 billion and operating margins of 33%. The board authorized a $1.5 billion stock buyback program through January 2021. The existing $1 billion authorization has $243 million remaining. Shares were also hit by the Mexican tariffs.


Uber (UBER) reported its first earning as a public company and they failed to impress. The company reported a loss of $1.01 billion for the quarter of -$2.26 per share. The loss was slightly better than the $1.00-$1.11 billion guidance. Revenue of $3.1 billion matched estimates.

Costs rose 35%. Gross bookings rose 34% to $14.6 billion from Q1-2018. Bookings rose only 3.4% from the prior quarter. Active users rose from 91 million to 93 million quarter to quarter. They did not provide Q2 guidance in the report. Shares rose at the open but quickly sold off with a little short covering at the close.


Dollar Tree (DLTR) overcame a negative market after reporting earnings of $1.14 that matched estimates. Revenue of $5.81 billion narrowly beat estimates for $5.78 billion. Same store sales rose 2.5% at Dollar Tree and 1.9% at Family Dollar. Analysts were expecting 2.1% overall so that matched estimates as well. The company guided for Q2 revenue of $5.66-$5.76 billion and earnings of 64-73 cents. Same store sales are expected in the low single-digits. Analysts were expecting $5.73 billion and 99 cents.

Full year guidance was $23.51-$23.83 billion and earnings of $4.77-$5.07. Analysts were expecting $23.67 billion, earnings of $5.30 and same store sales growth of 2.0%. So here is the problem. They only matched Q1 estimates, missed on Q2 and full year guidance. So why was the stock up $3.28 for the day? They are planning on closing 390 underperforming stores in Q2 and that will impact revenue and earnings, thus the lowered guidance. They are also planning on introducing Dollar Tree Plus, which will have items that cost more than $1 therefore a larger margin. They are also going to add adult beverages to their product offerings. Investors seemed to like the news.


If it is the weekend it must be time for an Apple update. Shares continue to fall on daily downgrades to sales expectations in China and worries about the tariff issue. I had heard that Apple had considered building a manufacturing facility with Foxconn in Mexico. Labor is cheap and importing into the US is by truck not ship or planes. If that was an actual consideration, they may be rethinking that plan.

Despite all the geopolitical issues we are only about three months away from the annual iPhone launch. Other than having three cameras rumored on the iPhone 11, the rest of the launch models are not generating any buzz. Apparently, Apple has run out of new and clever things to add to the iPhone models. There is a cheaper version with an LCD screen that could be a successor to the iPhone XR. Since this generation of phones will not have 5G the excitement is likely to fade quickly. Apple wants investors to focus on services revenue rather than iPhone sales, but phone sales are required to boost services revenue. Shares closed at $175 on Friday, down -17.5% since the May 3rd close. I said last week I would be a buyer in the $170-$175 range but the market must heal first.


The Mexican tariff proposal crushed crude prices for two reasons. We import 680,000 bpd of oil from Mexico. Every 5% increase in the tariff would raise the price to buyers by $2 million a day. More importantly, the potential for a trade war with Mexico in addition to the trade war with China and weak global economy caused traders to worry about future demand. Prices have been weak due to oversupply but a sharp decline in demand could push them significantly lower.

OPEC produced 60,000 bpd less in April because of a 400,000 bpd drop in Iranian exports. Saudi Arabia increased exports by 200,000 bpd to offset the Iranian shortage. There is plenty of oil in inventory and there is no need for any OPEC country to boost production any further.

Russian production is coming back online after the pipelines were sabotaged several weeks ago. More than 20 million barrels of Russian oil was contaminated with a strong corrosive. Those barrels had to be purified and the pipelines cleaned before anyone would buy Russian oil.

US production rebounded to 12.3 million bpd once again to offset the increased demand by refiners.

Shale producers are struggling. With oil prices falling back to the low $50s the pace of activity is going to slow significantly. White Star Petroleum filed for bankruptcy on Tuesday. They are likely to be followed by a dozen more companies. According to Rystad Energy, 8 out of 10 US shale drillers are burning cash. Out of 40 drillers surveyed only 4 had positive cash flow. With oil prices crashing it prevents them from coming back to the equity market for needed funds.

As I have written many times in the past, the shale drillers are on a production treadmill. They must keep drilling at a frantic pace to offset the rapid decline of shale production. Production can decline 50% or more in the first year and another 75% in the second year before leveling out at a trickle compared to their initial flows. In an analysis of shale fields David Hughes found that shale wells are 70-90% depleted by year three and fields without new drilling decline at 20-40% per year after the first two years. ShaleBubble.org That means producers must recover their costs in the first two years and provide enough money to drill new wells to offset the rapid decline in last year's wells. The instant they stop drilling, production begins to decline sharply and cash flow along with it.

The Exxon CEO said last week that the majors are not going to bail out the minors as the shale bubble bursts. "There is not always alignment among buyers and sellers." This means the smaller companies are not being realistic in their pricing and without a real bargain, Exxon is not a buyer.





Markets

Last weekend I predicted a continued decline and there is nothing in the charts that suggests anything different this week. However, the market is oversold and there is likely a short squeeze lurking in the near future. It may be powered by a tweet saying Mexico has agreed to work on the migrant problem and the tariffs have been postponed. There is no telling what headline will appear to trigger that short squeeze.

Secondarily, the 2,750 level on the S&P is considered fair value. That suggests the selling pressure may ease. I am sure there are portfolio managers hoping for a dip to 2,632 as a major buying opportunity but we do not know if they have the guts to wait it out if a short squeeze appears. They may decide that 2,750 was also a bargain.

The challenge is that the Chinese trade dispute has morphed into a cold war only that war is heating up with China's white paper and enemies list being made public this weekend. This will undoubtedly have a major impact on the Sunday evening futures. There is always the possibility they are going to soft peddle the issues in an attempt to bring the US back to the table, but I would not hold my breath.

Investors must deal with the potential for the issues with China and Mexico to flare up even more. It is possible. We can't always expect that situations will fade into an eventual solution. They also need to deal with the impeachment cloud that is hovering over Washington. That means there is not going to be any legislation in the near future and Congress is hopelessly gridlocked. Normally the market does well with gridlock but we have never had such a vocal war between opposing sides.

Declines in May typically lead to rebounds in June followed by a slide into the summer doldrums. Summer rallies do occur, but they are the exception rather than the rule.

The key focus for next week will be the 2722-2737 support and resistance at 2,800. If the S&P continues lower and breaks that support, then 2625-2632 should be the next target. Any rebound is going to be challenged by prior support, now resistance at 2,800.


Unfortunately, the Dow has already closed below the corresponding support level at 25,000. Friday's decline blew through that level and appears to be targeting the 10% correction level at 24,145. The Dow closed at a four-month low and has a significant lack of material support. Only four Dow components posted gains for the month.

The Dow has declined 1,881 points since the cycle high on April 23rd. This is the longest losing streak since 2011.



The two Nasdaq indexes are suffering from the same pressures with closes under the 200-day averages. The big cap tech stocks are sick with the China flu and worries over social media regulation. News that the DOJ was preparing an antitrust probe against Google did not help the market. They just agreed to pay the EU $1.7 billion for breaking antitrust rules in advertising. They had a $2.7 billion fine in 2017 and a $5.1 billion charge against the Android operating system in 2018. Multiple lawmakers are on a crusade to breakup Facebook and Google so the DOJ news was troubling.

On Thursday a judge ordered Facebook to turn over data privacy records and detail how it handled user data. Shareholders have sued claiming board members may have committed wrongdoing in connection to data privacy. Facebook may not fare well if their internal content rules are exposed in a legal battle. Multiple lawmakers have called Facebook to task for been deleting accounts of conservative pundits by the hundreds for "rules violations" ahead of the 2020 elections. They will not say what the rules are or what rule was broken. Strangely liberal pundits are not censored and thousands of wackos continue to post unimpeded by any form of civility. Lawmakers have asked multiple times why only conservatives are deleted and receive only the standard answers that rules were broken. Rant off!

These challenges to Facebook and Google are causing those megacaps to lead the indexes lower. Add in Apple and you have nearly $2 trillion in market cap in just three stocks that are leading the tech sector lower.




The Russell 2000 has declined -7.9% since the May 3rd close. The small caps have been leading the markets lower and they could be on the verge of a serious support break that could see another 5% decline.


On Saturday the Mexican president hinted his country "could" tighten migration controls in order to eliminate the tariff threat on Mexican goods. Obrador said Mexico "could" be ready to step up measures to contain migration in order to reach a deal with the US. This was a repeat of comments on Friday afternoon. He said he expects "good results" from talks planned in Washington next week. With more than 4,000 migrants crossing the border daily it is going to be a challenge.

There will be a fight, but Trump's Art of the Deal strategy is to bluster big changes and threaten big penalties. He has been successful with everyone but China. Mexico is too dependent on the US to put up much resistance. How far the president will carry the fight is unknown, but he is passionate about the border crisis.

The market is likely to react to every headline but being oversold already means there may be less risk to the downside. Markets do not move straight up or straight down without a period to reset every few days. There is nothing in the charts or in the headlines to suggest a rally ahead other than the potential for a short squeeze. Follow the trend until it ends.

Enter passively and exit aggressively!

Jim Brown

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