I closed with that statement last week and Powell proved it to be true on Wednesday.

Weekly Statistics

Friday Statistics

While Q2 earnings are expected to decline by -0.4% after only 1.4% rise in Q1, the big cap markets have broken out to new highs thanks to the outlook for rate cuts. Even the lingering uncertainty over Chinese trade talks and the potential for military action in the Persian Gulf have been unable to hold the markets back. With the breakout to new highs we have officially entered FOMO territory where investors will chase prices for fear of missing out.

There have been four times as many earnings warnings than positive guidance upgrades for Q2 and investors do not seem to care. At this point expectations are so low that we have moved into the "just don't screw it up" phase. Investors are expecting earnings to be flat while hoping for a minor upside surprise. Since estimates for the next four quarters are for only 4% growth on average, everyone is just hoping for a neutral Q2, so future estimates do not decline.

The markets had stalled their upward trajectory ahead of the Powell testimony on Wednesday but exploded higher once those prepared remarks were released. With the Fed seemingly on track for 2-3 cuts over the next six months, investors were celebrating.


There is currently a 100% chance of a 25-point rate cut at the July meeting with a 22.5% chance for a 50-point cut. The current rate of 225-250 is not even represented on the futures chart because there is zero chance of rates staying the same.

For the January meeting there is roughly a 64% chance for a total of 3 rate cuts to a 150-175 basis point rate. This is astounding for an economy not in recession. The Fed is being forced to do this to offset the global economic weakness, stimulus by other central banks and uncertainty over the Chinese trade war.



There was only one economic report on Friday and that was the Producer Price Index for June. There was still no inflation present with overall prices rising only +0.1% and core inflation flat at unchanged for the third consecutive month. Goods inflation declined -0.4% while services prices rose +0.4%. Intermediate processed goods declined -1.1% while unprocessed goods declined -3.3%. Core processed goods declined -0.1% but unprocessed goods fell a whopping -7.6%.

The headline number would have been significantly lower were it not for the 19.9% rise in corn prices due to late spring flooding. This influences multiple sectors including food, animal feed and ethanol prices.

Producer prices are up +1.6% over the trailing 12-month period. Core unprocessed goods are down -15.9% over the same period. Inflation is plunging with competition forcing prices lower.


The economic calendar for next week is rather tame and will be ignored because of the arrival of Q2 earnings. The housing reports, retail sales and the Philly Fed Survey will be the highlights. The Fed Beige Book is important but unless several districts suddenly report a sharp drop in economic activity it will be ignored.


This is bank earnings week. Goldman Sachs and JP Morgan will get the most attention and the rest will trail in their shadows. IBM, Netflix and Ebay will kick off the big cap techs on Wednesday. IBM completed the acquisition of Red Hat after the close on Monday, so their earnings guidance is going to be confusing at best.

Microsoft is the sleeping giant and shares closed at a new high on Friday. Their market cap is now $1.064 trillion and more than Amazon ($990B) and Apple ($935B).


Non-techs UnitedHealth and American Express will close the week.


There were only a couple of companies with material earnings last week. Delta (DAL) reported earnings on Thursday of $2.35 that rose 39% and beat estimates for $2.28. Revenue rose 6.5% to $12.54 billion. The carrier said it benefitted from higher fares and full planes since the 737 MAX fleet has been grounded. Most domestic flights from all airlines have been at capacity since the grounding. Discount fare programs have shrunk to almost nonexistent given the lack of excess capacity.

The company raised its full year earnings guidance from $6.00-$7.00 per share to $6.75-$7.25 per share.

Delta is expected to submit a bid on Monday for up to 15% of Air Alitalia. The airline has filed bankruptcy twice in the last ten years. Railway operator Ferrovia and the Italian Treasury are expected to own 50%. Delta already owns 49% of Virgin Atlantic and Aeromexico with smaller stakes in Air France-KLM, Brazil's Gol Linhas and China Eastern Airlines. Adding a stake in Alitalia would boost Delta's grip on international travel. Shares closed at a new high on Friday.


Another retailer could be headed for that great vacant mall in the sky. Bed Bath and Beyond (BBBY) reported "adjusted" earnings of 12 cents, down from 38 cents in the year ago quarter. For GAAP earnings they lost $2.91 per share on revenue of $2.57 billion. The company took an impairment charge of $401 million, only slightly better than the $500 million charge in the prior quarter. Sales declined 6.5% year over year but are down -44% for the last 12 months. Needless to say, they missed all the estimates.

Analysts claim the stores are understaffed, have shrinking inventory and declining market share. Competition with Target, Walmart and Amazon is proving to be nearly impossible. The new CEO of two months has a herculean task ahead of her and she knows it. She said in order to compete "we need to give consumers a reason to keep shopping in our brick and mortar stores and in order to do that we need to update the stores and enhance the shopping experience." Unfortunately, that costs money and unless consumers drop in, they will never know anything has changed.

BBBY is heading the way of dozens of other retailers. They are following the path of Sears where inventory became nonexistent and salespeople even scarcer. Shares closed at a multiyear low and more than likely will move lower.


Shareholders of Tower International (TOWR) received a nice surprise on Friday. Autokiniton Global Group announced it was acquiring Tower for $31 per share in cash. That was a 70% premium to Thursday's close. The total value of the transaction was $900 million including debt. Tower is a leading maker of structural metal components for the automotive sector. Tower has a 35 day "go shop" period where they may solicit a better offer.


On Thursday, President Trump dropped his plans for curbing drug rebates to pharmacy benefit managers (PBMs). With the rebate ban off the table Cigna (CI) and Humana (HUM) exploded higher. Cigna recently acquired Express Scripts for $67 billion and that gave them a huge exposure to the PBM business. PBMs help manage prescription claims for insurers and Medicare Part D plans. Tens of billions of dollars of rebates flow through these PBMs.



Thursday after the close Illumina (ILMN) cut its revenue guidance and shares imploded. The company said revenue would be in the range of $835 million compared to $830 million in the year ago quarter. They said revenue would decline by $50 million due to issues with its population genomics initiatives. The CEO said their analysis suggests the challenges are transitory and do not reflect a macro change in the business. That did not help the stock price.


Johnson & Johnson (JNJ) shares fell sharply after Bloomberg said the company was facing a criminal probe about the potential cancer risks in baby powder. JNJ has repeatedly denied there was asbestos in baby powder, but the stories will not die. JNJ disclosed in its annual report it had received subpoenas from the Justice Dept and the SEC related to the ongoing investigation. They told Reuters on Friday there had not been any new developments in the matter.

JNJ is the defendant in suits by more than 14,000 plaintiffs who allege the product gave them cancer. Reuters released an article on December 14th claiming JNJ had known for decades that small amounts of asbestos had been found in its products in more than 30 years of tests begun in 1970. Not only will it be tough to prove that baby powder decades ago contained asbestos, but it will also be hard to prove that the baby powder caused someone's cancer a decade or more after use.


Facebook shares surged late Friday after Bloomberg said the FTC had voted to impose a $5 billion fine for privacy issues. Facebook had previously taken a reserve of $3 billion in anticipation of a fine but said the number could rise to as much as $5 billion. Facebook has $45 billion in cash, so this is not material. However, it also puts Facebook on notice that any future problems could trigger significantly higher fines and regulations. The details of the settlement have not yet been disclosed and there could be other measures imposed to try and prevent future data breaches. The deal reportedly still needs to be approved by the Justice Dept.

The settlement is actually positive for Facebook because it lessens the chance for a breakup at least on the current issues. If there is another Cambridge Analytica event in the future, the company will probably not be so lucky. That would prove they cannot be regulated in their current form because they are too complex. Splitting them into their component parts of Facebook, Instagram, WhatsApp, etc could reduce that complexity.

The plan to create the global Libra digital currency is drawing a lot of heat and calls for severe regulation. Creating a currency that could be used for purchases in 144 countries could upset the global currency markets. Having 2.6 billion users with access to that currency is the biggest selling point and the biggest problem. Multiple countries are talking about financial regulation if they go ahead with the plan.

Facebook, Amazon, Google and Apple will all face an antitrust hearing in the House at 2:PM on Tuesday. The hearing is titled "Online Platforms and Market Power." The FTC and Justice Dept recently agreed on areas of responsibility over antitrust issues for those four companies. They are now pursuing antitrust probes in their designated areas and they will include the impact of prior acquisitions.


Crude prices rocketed higher after Iran tried to hijack a British oil tanker in the Persian Gulf. Three Revolutionary Guard boats were turned away by a British navy vessel. It would have been no contest.

Hurricane Barry shutdown 1.1 million bpd of crude production in the Gulf of Mexico and that also helped to lift prices. That threat has passed, and production is already being restarted. Gasoline prices rose about a nickel ahead of the weekend.

Inventories have been trending lower as is normally the case in the summer but the summer is rapidly coming to a close. School in our area restarts in just over four weeks. All the back to school sales are in full swing. This suggests that the normal decline in crude prices in late August could retest the low $50s by mid September.





Markets

The S&P pushed through resistance at 2,954 the prior week then retraced some of its gains while investors waited for Powell to testify. They were rewarded with the ideal situation and the indexes rebounded sharply to close at new highs.

The challenge for this week is whether the breakout continues if some of the early reporters disappoint on earnings. If those earnings are better than expected I would not be surprised to see a continued relief surge. The FOMO buyers will be providing the buying at new highs. On the flip side, if we see a flurry of mild earnings disappointments the markets will likely wander aimlessly in search of direction. Rate cuts still trump earnings but that is a longer-term process compared to the individual declines on earnings disappointments.

Current short-term support is roughly 2,990 followed by 2,970. After two weeks of gains it would not be unusual to see some profit taking but the trend should still be higher for the next couple of weeks.


Boeing was a major market driver for the Dow with a $15 rebound over the last two days. That accounted for well over 100 Dow points. UnitedHealth was up on the rebate ban. Caterpillar was up sharply on no news and 3M rallied despite a $20 target price downgrade by UBS.

Home Depot received its normal hurricane boost on the idea that reconstruction will require tens of millions of dollars of lumber, sheetrock and paint in Louisiana. It did not hurt that Goldman initiated coverage with a buy rating and $235 price target.

The Dow exploded over round number resistance at 27,000 and closed at the high of the day on Friday. I would not be surprised with some retracement.



The Nasdaq did manage to make a new high, but it lagged the Dow and S&P in terms of relative performance. The chip sector rallied after Powell's testimony but there were still a lot of smaller tech stocks refusing to join the party. The index can only run so far on the strength of the big caps.

The resistance at 8164-8170 held the index back for a week and the Wednesday breakout was lackluster. The index pulled back on Thursday but surged with the broader markets on Friday. Investors like to chase new highs on the Nasdaq so let's hope this continues.



The Russell remains the anchor for the market. The small caps have not been able to make any material gains and just barely closed over correction resistance on Friday when the other indexes were surging. Apparently, investors are not confident the current rally is going to continue, and they are avoiding the small caps. Keep your eye on the Russell for long term market direction.


In theory the market should continue to edge higher as long as earnings are simply neutral. Nobody knows how negative earnings would have to be to overcome the rate cut sentiment, but I am thinking a 4-5% decline. I don't see that happening. At this point slightly negative economics are a plus because it solidifies the Fed rate cut plan. Much better than expected economics could derail the Fed. I do not see that happening either. I would continue to buy the dip until proven wrong by a short-term support break. August is when I will start to worry about a direction change.

Enter passively and exit aggressively!

Jim Brown

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