Last week saw the S&P and many securities reach either record or multiyear levels.

Weekly Statistics

Friday Statistics

The Dow hit an 8-month intraday high at 26,907 on Friday with a 154-point intraday gain. Unfortunately, it did not hold, and the index declined -188 points to close with a 34-point loss. A record close would have been over 26,828 but it closed 109 points short.

The S&P closed at a new high at 2,954 on Thursday and slipped back to lose about 4 points on Friday. It was a very close call with the index in positive territory until an options related dive at the close.

The Nasdaq Composite closed at 8,051 on Thursday and 113 points below the May 3rd high with a 20-point drop on Friday.

The Russell 2000 remains the laggard with a close 190 points below its prior high with a 12.3% decline and still in correction territory.



There was only one material economic report on Friday. That was the existing home sales for May. Annualized sales rose from 5.21 million to 5.34 million. The 2.5% increase for the month is still -1.1% down from the same period in 2018. There were 670,000 homes sold in the Northeast, 1.22 million in the Midwest, 2.32 million in the South and 1.13 million in the West. Months of supply rose from 4.2 to 4.3 after a low of 3.6 in February. Single family home sales were 4.75 million and multifamily sales were 590,000.

The average home price rose from $266,900 to $277,700. That represents a 4.8% rise over the same period in 2018. Sales of homes under $100,000 declined -12.4%, $100,000-$250,000 were flat and sales of homes $250,000-$500,000 rose 10.5%. Sales from $500,000-$750,000 rose 11.5%, $750,000-$1 million rose 8.1% while sales over $1 million rose 2.3%. Cash purchases accounted for 19% of all sales. Sales should continue to grow with the 30-year mortgage rate around 4.0%.


There is now a 100% chance of a rate cut at the July 31st meeting. There is a 28.1% of a 50-basis point cut. Investors wondering why the Fed would cut 50 points in a booming market should think back to other rate cut events that started with 50-point cuts. In 1997 the Fed cut 50 points after the LTCM disaster and the Russian debt default. In 2001 and 2007 the Fed cut 50 points to try and head off recessions. Both times they were too late. This time the Fed is trying to be proactive and head off the global weakness and the impact of the Chinese tariffs. They do not want to be behind the curve again as US economics weaken in response to global events. As a result, the yield on the ten-year traded under 2.0% on Thursday and the lowest level since November 2016 just prior to the election.


The dollar declined -1.75 on the Dollar Index and a very unusual four day move. This is positive for earnings and for sales of US products overseas.


The falling dollar, fear of war with Iran, falling interest rates and yields all combined to lift gold to a 6-year high.


The next revision of the Q1 GDP is coming out this week. The recent economic reports have pushed the Atlanta Fed real time GDPNow forecast to 2.0% growth for Q2.


A couple weeks ago the PMI Services for May came in at 50.9. That is the lowest level since February 2016. That is a 39-month low. The Manufacturing PMI came in at 50.5 and a 117-month low. New orders were in correction under 50 and at ten-year lows.

While the normal weekly data is choppy and declining slightly, the longer-term data is in a very bearish trend. The trade war and tariffs are the cause of this deceleration. Whether or not the Fed can reverse this trend with another round of rate cuts is unknown.

The calendar for next week has an eclectic mix of data. Home sales are back again as well as the GDP and several regional Fed reports. The biggest item on the calendar is the G20 meeting and the potential for either an end to the trade war with China or an acceleration into a new round of tariffs. The new market highs would evaporate instantly if that was the case.


First quarter earnings are over. There are still three companies that have not reported but the early reporters for Q2 are already lining up. Earnings growth ended Q1 at 1.6% with 5.6% revenue growth.

There have been 82 earnings warnings for Q2 and nearing that critical 20% threshold. There have been 24 guidance upgrades. There are 12 S&P companies reporting next week. The expected earnings growth for Q2 is only 0.2% but early estimates are normally low. In Q1 the forecast fell to -2.0% but we ended the quarter positive.

Fedex is going to be important because the last two quarters they warned about a slowdown in global shipments. This is expected to have continued. Micron will be important because of the five additional Chinese companies that were blacklisted last week. Nike reports on Thursday and they are tariff bait. They have a lot of exposure to China. Constellation Brands reports on Friday and could take a hit from its exposure to Canopy Growth.


CarMax (KMX) reported earnings of $1.59 that rose 19.5% and easily beat estimates for $1.49. Revenue of $5.366 billion rose 12% and beat estimates for $5.179 billion. Overall same store sales rose 13% while used unit sales rose 9.5%. Used vehicle profits rose slightly to 13.1% with the average profit per vehicle at $2,215. Wholesale vehicle profits rose 9.8% to $1.043 and driven by a 6.6% increase in unit sales. They repurchased 3.0 million shares for $204.8 million during the quarter. They have $1.91 billion remaining under the existing authorization. Shares spiked over 5% at the open but faded to post a 3% gain.

With auto sales remaining relatively strong, CarMax and AutoNation should continue to prosper. Lower interest rates are fueling a boom in sales. Lower fuel prices stimulate auto buying with high profit SUVs the preferred vehicle.


Red Hat (RHT) reported adjusted earnings of $1.00 that beat estimates for 87 cents. Revenue rose 15% to $934.0 million and beat estimates for $931.6 million. Revenue from application development and technology subscriptions rose 24% to $235 million. Red Hat is going to be a big plus for IBM when the acquisition is completed. IBM will be able to expand market share and profits despite the high $34 billion price they are paying.

IDC believes applications running on Red Hat Enterprise Linux (RHEL) will contribute more than $10 trillion in global business revenues in 2019. That compares to the IDC projection of $188 trillion for total business revenue. IDC said $81 trillion was IT revenue. Red Hat software accounts for 25% of all corporate Linux operating systems. This suggests IBM is buying the goose that will be laying golden eggs in the future.


Canopy Growth (CGC) reported a 312% rise in revenue to C$94.1 million compared to estimates for C$92.6 million. The company reported a loss before EBITDA of C$98 million and much larger than estimates for a C$64 million loss. Adjusted gross margin was 16% and missed estimates for 24%. The CEO said they expect 40% margins by the end of 2019. They are in extreme growth mode now and are spending huge sums of money on growing space and product development. He said Q1 would be the bottom on margins. They sold 9,326 kg (20,560 pounds) of cannabis in Q1. They now have 600,000 sqft of growing space.

They had previously announced they were acquiring skincare company The Works for C$73.8 million to add beauty and sleep products to their portfolio. They also said they had received shareholder approval for the $3.4 billion acquisition of Acreage Holdings, the largest grower in the US. The deal cannot complete until the federal laws change in the US and they said 2021 is the first chance of that coming to pass. They warned that the acquisitions would cause a materially significant non-cash charge in the current quarter.

Shares declined on the margin miss despite the 300% increase in revenue. This is short sighted in my opinion. I think everyone understands we are moving towards deregulation in the US. More than 30 states now have some form of legal use. Stifel analysts believe the market will reach $28 billion in Canada and $100 billion in the US once legalization occurs. Canopy's revenue in the quarter was only C$98 million (US $75 million). There is an opportunity for extreme growth over the next decade and possibly a lot sooner.


Kroger (KR) shares tanked after reporting earnings of 72 cents that beat estimates by a penny but also declined a penny from the year ago quarter. Revenue declined slightly from $37.72 billion to $37.25 billion but still beat estimates for $37.19 billion.

Investors should not have reacted negatively. This quarter reflected the 2018 sale of their convenience store business and the resulting loss of revenue. The $2.15 billion sale of 762 stores in 18 states removed $4 billion in annual revenue and expenses related to the 11,000 employees. Kroger used $1.2 billion of the proceeds to repurchase 36.1 million shares. The sale closed in April 2018.

Comparing Q1 2018 revenue to Q1 2019 is apples and oranges. I believe investors should have been excited that revenue only declined about $480 million despite a loss of $4 billion in convenience store revenue. That suggests they had a great quarter. Same store sales rose 1.5% and online sales rose a whopping 42%. They guided for the full year for same store sales of 2.00-2.25% and earnings of $2.15-$2.25. Now that they are free from those comparisons, I would expect good news on the next earnings report.


Bitcoin came back from the dead over the last two months with a surge from $3,232 in December to $11,030 this weekend. Part of the reason for the surge was the volatility in global currencies and the tariffs on China. Another reason was the pending announcement of Facebook's Libra coin. The company is planning on creating a "simple global financial infrastructure" using Zuckerberg's own words. The Libra currency will be a "stablecoin" which means its value will always be tied to the underlying currencies and not fluctuate like bitcoin. That makes it highly desirable for international trading and less desirable as a trading vehicle. For instance, nobody wants to sell a house in France for 1,000 bitcoins and find out several weeks later when you try to buy a house in the US that your bitcoins have each fallen a couple thousand dollars in value. Selling your house in Libra for the equivalent of $250,000 would still be worth $250,000 days, weeks or even years later and those coins could be used anywhere in the world.

Facebook will use a basket of currencies including the dollar and the euro to establish the underlying value. Initially transactions can be made "seamlessly" through WhatsApp and Messenger but will also be available on dozens of other messaging platforms around the world. The currency will be backed by a blockchain called the "Libra Protocol" and validated by multiple major corporations to provide transparency and stability. The coin will be managed by the "Libra Association" and run through the Libra Blockchain. The currency is expected to be launched in 2020 and Facebook will be the manager of the startup effort through 2019.

The initial management consortium consists of 27 high profile companies including Visa, MasterCard, Paypal, Booking Holdings, Uber, Lyft, Stripe, Ebay, etc.


Facebook claims the Libra initiative is aimed at the unbanked around the world starting with its nearly 3 billion Facebook members. Worldwide there are billions of people without bank accounts or credit cards. They do have smartphones. This opens up a world of opportunities for them such as online shopping that we take for granted in the US.

The coming of Libra has rekindled interest in bitcoin over the last two months. There is no way Facebook could have generated commitments from that number of sponsors above and kept the project a secret. Because Libra will validate stable blockchain currency for the working class, bitcoin found new life. In the end, Libra could kill bitcoin through ease of use and wide acceptance but for today there is new life.

Bitcoin is confidential and can be used for things that are not always legal. Libra will not be confidential, and Zuckerberg made a point of saying that transaction records would be available for police in the event of illegal transactions. Sell drugs, go to jail, or at least that is the theory.


The US Commerce Dept said it was adding five more Chinese companies to the sales blacklist. The dept said these companies did not operate in the best interests of the US and chip sales to them were now banned. The goal is to prevent China from using our own technology against us. These companies are developing super computers, AI and numerous military applications. It makes no sense to sell China's military chips to be used in military satellites, missiles and military equipment. US technology is the highest in the world and that gives us an edge over hostile powers without it.

The ban prevents Intel and AMD from selling high performance multicore processors to entities building super computers to simulate nuclear explosions and military simulation activities. Since 2015 China's National University of Defense Technology (NUDT) has been blacklisted for these reasons. The US recently discovered that NUDT had been using four separate companies and shipping addresses to circumvent the ban.

The Commerce Dept said the companies added to the list "pose a significant risk of being or becoming involved in activities contrary to the national security and foreign policy interests of the US." Chip stocks declined again on Friday after the announcement.

Over the weekend Eldorado Resorts (ERI) and Caesars Entertainment Corp (CZ) reportedly agreed to merge in a cash and stock deal worth about $18 billion including debt. Caesars closed at $9.99 and the deal values them around $13. Caesars operates 67 properties in six countries. Eldorado operates 26 domestic properties and is valued at $4 billion. The deal is expected to be announced on Monday.



The conflict with Iran caused crude prices to rocket higher. Just because President Trump called off a missile attack because of expected casualties, it does not mean the conflict will not lead to further military involvement. Iran said it could have shot down a Navy P-8 patrol aircraft with 35 personnel aboard, but they decided to let it pass. Obviously had they shot down that plane the military reaction would have been significantly worse. That is always a threat now that Iran believe the US is weak because they did not respond. Until the US military strikes back hard, Iran will be tempted to cause more trouble.

Iran only understands force. They have threatened to declare war around the world using their various proxies if the US strikes back. If we do not respond to their aggression, they will press the envelope.

Oil prices moved over $57 after hovering just over $50 the prior week. If there is a shooting war in the Persian Gulf, prices will move a lot higher. Iran also launched cruise missiles into Saudi Arabia and hit a power plant. There has not been a Saudi response but that does not mean there will not be one. If those two countries decide to fight, the oil facilities will be the main targets.

Active rigs declined by 2 last week with gas rigs falling by -4. A sustained crude price for several weeks could trigger the activation of some dormant oil rigs.

We finally got the Drilled but Uncompleted report from the EIA for May. The number of DUC wells rose by 41 in the Permian but declined in all other areas. The total is still well over 8,000 and that is a lot of completions to be scheduled when prices and pipeline capacity permit.






Markets

Analysts believe far too many bridges were burned in the negotiations between the US and China when they walked away from the table in May. While President Trump and President Xi will meet next week at the G20 there is not likely to be a deal. Even if both agreed to move forward it would still take weeks to put the deal on paper and then have a big signing party in a neutral location.

Analysts believe that regardless of the outcome of the meeting, Trump will increase tariffs on Chinese goods in order to apply more pressure. China will retaliate. Since agreeing to a deal after the imposition of new tariffs would look like Xi caved into pressure from the US, this would be shaky ground for Trump to cross.

IF, they do decide to begin talks again the meeting will probably break up with both sides proclaiming common ground and progress in the ongoing trade talks. Since Trump needs a quick resolution and a deal he can use in his reelection campaign, he may be more interested in getting something accomplished than coming out a big winner. If he gets any deal now, he can always come back again in 2021 and apply pressure again.

Unless the meeting ends in another walkout, the market will likely see the results as optimistic and indexes rise. A positive comment would be Trump saying we made good progress and there is no need for additional tariffs. An outstanding event would be Trump agreeing to cancel existing tariffs because of good progress. Nobody expects that to happen. Trump will want to keep the pressure on until a deal is signed.

Trump is also meeting with President Vladamir Putin at the G20. Nothing is expected to develop from that visit.

This is the risk for the market next week. Since the G20 meeting is Friday and Saturday for the heads of state, the market will trade on expectations or lack thereof all week. The speech by Powell on Tuesday will also be a pivotal point. If he tries to walk back some of the dovish comments the market could react negatively.

The S&P closed only 5 points over the May 3rd high of 2,945. This could be seen as strong resistance until we move significantly higher. Support is well below at 2,872 so there is a wide range for the index to run without impacting overall market direction. Volume is expected to be weak ahead of the July 4th holiday but once the bulls begin to stampede, anything is possible.


The Dow is struggling to close at a new high. The index traded over the 26,828 level on Friday with a brief print over 29,000 but then closed -182 points below the intraday high. The index was up +154 at the high of the day.

There were only a handful of stocks with moves over $1 with the rest of the components only fractionally changed. Most of the movement was more than likely related to option expiration.



The Nasdaq remains about 135 points below the May high at 8,164. The big cap techs were slightly negative overall but were helped by big gains in Google and Bookings. That kept the Nasdaq 100 to only a loss of 9 points.

The FAANG stocks were all positive for the week and that helped produce the 3% gain in the Nasdaq 100. Facebook was a big contributor with the Libra announcement. With a weak chip sector and big gains in June, the Nasdaq is going to have a tough road higher.



The Russell was again the weakest index. After failing at the 10% resistance level at 1,566 on Thursday the index retraced its gains with nearly a 1% decline on Friday. Fund managers are still not convinced they should be buying small caps ahead of the summer doldrums and potential G20 disaster.


We have had a great run in June after a terrible May. That is a trend that repeats quite often. However, there is another trend and that is the summer doldrums when the market suffers from lack of interest. Investors do not want to be heavily invested while they are on vacation. Volume tends to die and were it not for the Q2 earnings in late July, the market would be a ghost town. I continue to recommend not being overly long ahead of the G20 showdown. We could more 5% in either direction after the event. Given the strong gains in June, the path of least resistance is lower.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

 

"We are all born ignorant, but one must work hard to remain stupid."

Benjamin Franklin


If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Do not wait until you miss a newsletter to decide you want to take the plunge.

subscribe now