A stronger than expected payroll report dimmed expectations for a large rate cut.
The market had worked itself into a frenzy with expectations for a 50-basis point rate cut at the July 31st FOMC meeting. The stronger than expected jobs report dashed those hopes and the Dow fell -232 at the open. At least that was the conventional wisdom being spread around on stock TV. While I am sure there was some truth to that story, the lack of volume in an oversold market let those taking new high profits, push the market lower at the open.
The only economic report on Friday was the Nonfarm Payrolls for June. The economy created 224,000 jobs in June compared to estimates for 75,000. May was revised lower from 75,000 to 72,000 and April was revised lower from 224,000 to 216,000.
The unemployment rate rose from 3.6% to 3.7% because of more people entering the workforce. The average monthly jobs for Q2 were 171,000 per month and about twice what are needed to keep pace with the growing workforce. This is down from the 200,000 average rate in 2018. The labor force participation rate increased one tenth to 62.9%. Some 335,000 people joined the workforce. This is related to the 2019 graduating class heading out to find their first real job. This was up from 179,000 in May.
Goods producing jobs rose 37,000 and service jobs rose 187,000. There was not a big surge in census hiring. Only 33,000 jobs came from federal government sources and there will eventually be hundreds of thousands when they begin ramping up. The labor market has grown every month for 114 consecutive months and the longest ever period of growth.
Education and health services added 61,000 jobs, professional and business services 51,000, Transportation and warehousing 23,900, construction 21,000, manufacturing 17,000 and leisure and hospitality only 8,000. That last number is bullish because it has declined significantly. Workers are finding more stable, higher paying jobs and are not being forced to work as a waiter or bartender to make ends meet. Retail lost 5,800 jobs and mining (energy) lost 1,000.
The floods in the Midwest were blamed for the low numbers in May. If that was the case, we should continue to see strong job growth in the 185,000-215,000 range for the rest of the year.
The surprise in the payroll report reduced the odds of a 50-point cut from about 50% to 4.9% or next to impossible. There is a 100% chance of a 25-point cut to head off weakness from the global economy.
The yield on the ten-year note also spiked with the decline in rate cut expectations. The 1.95% level was a two-year low.
The calendar for next week has four opportunities for market disruption. Chairman Jerome Powell speaks on "Stress Testing" on Tuesday. That is expected to be a tame speech and not deal with rate policy. However, on Wednesday and Thursday he gives testimony to Congress and in each instance, he will be rigorously questioned about his plans and his ability to withstand President Trump's calls for lower rates. The Wednesday session will be the most dangerous with Thursday just a recap of what was said on Wednesday. Also, on Wednesday we will get the minutes from the last FOMC meeting and analysts will be searching for rate cut clues.
Thursday and Friday have the inflation reports in the CPI and PPI. This impacts the Fed's outlook on inflation, and they are not expected to show any signs of rising prices.
The first trickle of Q2 earnings reporters will appear next week with Pepsico, Bed, Bath and Beyond, Delta Airlines and Fastenal.
So far in the Q2 cycle, 21 companies have reported, and earnings growth has been zero with revenue growth at 3.4%. Of those reported 86% have beaten on earnings estimates and 76% have beaten revenue estimates. The current projections are for earnings growth of 0.7% and revenue growth of 3.4%. Typically, the early earnings forecasts are low by up to 3% and that suggests the overall quarter will still be positive.
June had the most Q2 earnings warnings at 85 since 2014. There were 23 guidance upgrades. The number of warnings, nearing 20% of the S&P, suggest this could be a rocky quarter.
There were no earnings of note last week.
Tesla (TSLA) surprised everyone with deliveries of 95,200 vehicles. Analysts were expecting 89,084. That included 77,550 Model 3s and beat estimates for 73,144. There were a combined 17,650 for the Model S and X. The prior record quarter was Q4 with 90,700 vehicle deliveries.
A challenge for Tesla was the 50% decline in the $7,500 tax credit at the end of December and that was cut again to $1,875 on Monday. It expires completely at the end of 2019. The drop in the tax credit in Q1 caused deliveries to plunge and triggered demand worries among analysts. Likewise, analysts said the surge in Q2 could have been customers pulling their orders forward to beat the second tax credit decline on July 1st.
There was also a help from the 10,600 vehicles in transit at the end of the first quarter. That provided an extra boost to the total deliveries in Q2. At the end of Q2 there were 7,400 vehicles in transit. Tesla said it would no longer provide that guidance. The latest guidance from Tesla is for delivery of 360,000-400,000 vehicles in 2019. Most analysts are skeptical since even the good Q2 quarter is likely surrounded by not only a poor Q1 but a potentially poor Q3 because of the reduced tax credit.
Tesla shares spiked on the news as shorts were forced to cover. I would still recommend buying long term puts on Tesla if the premiums were reasonable. There are far too many factors working against the company as competition increases. UBS just reiterated a sell rating and cut their price target from $200 to $160. Goldman reiterated a sell rating and cut their price target from $200 to $158. Barclays has a sell rating and cut their target from $192 to $150.
Rumors broke on Wednesday that Broadcom (AVGO) was in late stage talks to acquire Symantec. Shares of SYMC spiked from $21 to $25.50 on the news before fading. Symantec is one of the largest security software companies in the world, but shares have been struggling. Keeping management has been a systematic problem and that suggests there are internal issues. Investors saw a lack of synergies and Broadcom shares crashed.
On Wednesday news broke that Broadcom may also be interested in acquiring Tibco Software. Tibco platforms are used by Jet Blue, NASA, General Mills, Macy's Royal Caribbean and others. Tibco sold itself to PE firm Vista Equity Partners in 2014 for $4.3 billion.
Broadcom bought CA Technologies last year for $19 billion and software now accounts for about 25% of Broadcom's revenue. Broadcom is under investigation by the FTC for forcing customers into illegal contracts promising not to buy from competitors.
Electronic Arts (EA) shares fell 5% on Friday after they released the new version of Apex Legends. When legends first launched in early 2019, they quickly accumulated more than 10 million players. After the release of season 2, the game only had about 45,000 viewers on Twitch. That was down from 100,000 viewers a day back in March. Apparently, the interest in the game has died but some analysts are blaming it on the holiday weekend keeping players outside and away from their consoles.
Drug stocks declined on Friday after President Trump said they were working on a new drug pricing plan. US consumers would buy drugs based on the lowest prices paid by other countries. It is not fair for US consumers to pay $1,000 for the same drug that is sold for $100 in Europe. The plan would have a "favored nations" component for averaging down drug prices. The US pays the highest prices for drugs of any country.
Amazon filed a request with the FCC to launch 3,236 near earth satellites to offer satellite based broadband internet access. The plan would provide high speed access to "tens of millions" of underserved customers around the world. Bezos said the Kuiper project would cost "multiple billions of dollars" and it not related to his Blue Origin space launch company. Low orbit is considered 112 to 1,200 miles high. Amazon's satellites would orbit at 370-390 miles. In order to remain in orbit, they have to continually race around the earth with orbits as short as every 90 minutes. As one satellite moves out of range of ground receivers it passes off those connections to the next satellite in line and adds signals from new receivers it is approaching.
Elon Musk's Space X has already received approval for 11,943 satellites for the same purpose. They launched an initial batch of 60 in May and have already lost communications with three of them. Other companies with the same plan include Boeing, OneWeb and Leosat Enterprises. Combined they could launch more than 50,000 low orbit devices that are programmed to commit suicide by plunging into the atmosphere when their life cycle ends.
Amazon also said their system could provide mobile broadband to planes, ships and mobile vehicles.
In 2017 more than 26% of US consumers did not have any broadband service. In May the FCC said 33 million Americans do not have access to broadband. Worldwide 3.8 billion people do not have broadband access. Only about 20% of the earth is covered by cell towers.
In other news the divorce between Jeff Bezos and wife Mackenzie was finalized on Friday. She will receive $38.3 billion in Amazon stock, about 4%, and make her the world's 22nd richest person. Jeff will retain 12% worth $114.8 billion and he will remain the world's richest man. Mackenzie will give Jeff voting control of her stock to insure his continued leadership at Amazon. She also gave Jeff all her interest in the Washington Post and Blue Origin.
The co-CEOs at Canopy Growth are leaving. Bruce Linton, the public face of Canopy was terminated by the board. His counterpart Mark Zekulin said he would leave as soon as a replacement can be found. The exits are the result of Constellation Brands $4.1 billion investment. With that buy in and succeeding option exercises they acquired four of the seven board seats. After the big Q1 earnings disappointment the board, at least the Constellation side, believed they needed somebody with more experience running and building public companies. Linton and Zekulin had the foresight to start the company but neither are public company managers. Linton said he feared being displaced when he agreed to the Constellation investment, but it was too critical for Canopy and worth the risk. Linton was a pioneer for not just Canopy but the industry in general. He was also the visionary that crafted the agreement with Acreage Holdings that will eventually be acquired by Canopy.
Samsung Electronics warned on Friday that Q2 earnings could be cut in half because of weak demand that has intensified because of the trade war with China. Micron (MU) said it was experiencing "intense competition" from Samsung in the memory and storage markets. The memory chip price war is helping consumers but hurting both companies.
The oil market was relatively quiet after OPEC agreed to extend the 1.2 million bpd production cuts for the rest of 2019. Prices declined on the outlook for stables supplies.
However, over the weekend the UK seized the Iranian tanker Grace I which was transporting oil to Syria in violations of the EU sanctions. The tanker was carrying two million barrels of oil. Iran warned the UK to release the tanker immediately or face retaliation, which could include the seizure of a UK tanker in response. This is sure to cause another spike in prices next week. If Iran strikes out with protest attacks, the US is likely to intervene militarily.
Active oil rigs declined by five for the week ended on July 5th.
The S&P gained 17.35% in the first six months of 2019. That is only the tenth time in 70 years that it has gained over 15%. In those years the S&P declined an average of 12.5% in the second half of the year and as much as 34% in the crash of 1987. With Q2 earnings expected to be flat that would normally be a cause for worry. The prospect of rate cuts in a non-recession environment should fuel a continue rise. Rate cuts trump weak earnings.
However, the markets remain overbought after the big June rebound. It will be very interesting to see if investors are content to keep adding to positions at new highs.
The Dow has rebounded 8% over the last five weeks. The path has not been straight up but contained two pauses to refresh. The initial sprint paused on the 10th for several days and that was followed by another uptick on the 18th. The index again paused for several days as the headlines played out. In theory, this could continue for a long time if the pattern continues to repeat. The sprints are short squeezes and the pauses trick the shorts into building new positions only to be squeezed again. The pauses also allow time for investors to rationalize adding to positions.
The Dow recovered the initial drop on Friday to close with only a minor loss. The A/D line was roughly 2:1 in favor of decliners. We still have a week before the first Dow components begin reporting earnings. Without any China trade news next week, the headlines impacting Dow stocks should be slim.
The index is poised for a new leg higher, but we may need a catalyst to overcome the overbought conditions.
The S&P is well above the prior high at 2,954 and closing in on the 3,000 level. The index hit 2,995 on Wednesday and could test that 3,000 mark this week. With so many analysts having year end targets of 3,000-3,100 there will be a lot of incentive for fund managers to take some profits and lock in their performance bonuses for the year.
If by chance a sudden rally appeared that pushed the S&P past 3,100 it could get crazy. The price chasing would be extreme. While I am not expecting that the possibility does exist.
Support should be the prior high at 2,954.
The Nasdaq is still troubled by a group of large cap tech stocks that refuse to trend higher. Each has its own story and they cannot seem to maintain a trend. Should the Nasdaq breakout to a big new high, it could be a driving force for the rest of the market. Investors like to follow tech breakouts and the Nasdaq is very close.
The Russell 2000 was the only major index to post a gain on Friday. It was minimal but it was still a gain. There is the possibility that fund managers are switching out of big caps exposed to the global economic weakness and into domestically focused small caps. The more likely excuse is a continued adjustment of the Russell reconstitution the prior Friday. There were probably a few funds that had not completed their reconstitution.
I was cautious last week because of the expected short squeeze on Monday. I said Monday was not going to be an entry point. The Dow gapped opened on Monday to 26,890. After trading for the week, it closed on Friday at 26,925 only 35 points higher. While Monday was a short squeeze there was significant volatility the rest of the week. This was new high uncertainty. On the Dow we are nearing triple top resistance. A breakout here would be huge but it is also a potential failure point. This is normally a continuation pattern so plan for the breakout. If earnings are bad it may only be temporary but remember, rate cuts trump earnings.
Enter passively and exit aggressively!
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