The quadruple options expiration and the rebalancing of the S&P caused significant volatility on Friday.
It was an ugly day in the markets despite the relatively minor declines at the close. The Dow only lost -28 points but that was -158 points off its high at 16,456. The S&P lost -5 points to close at 1,866 but that was nearly -20 points below the new intraday high at 1,884 set early in the morning. The market started off with a bang for a quadruple witching with very heavy volume at the open that sent the indexes soaring and the S&P to a new high. Once that quadruple witching volume evaporated the market started to weaken.
However, the big push lower came from comments from Dallas Fed President Richard Fisher. He said October would be the right spot to end QE. Unfortunately that is about three months earlier than what the market expects. There are six more FOMC meetings in 2014 with the last one in December. If they continue to cut $10 billion at each meeting, effective the following month as they have been doing, QE would end in January and it would look like this.
Apr meet: Cut $10 B to $45 B starting May 1st
Jun meet: Cut $10 B to $35 B starting July 1st
Jul meet: Cut $10 B to $25 B starting Aug 1st
Sep meet: Cut $10 B to $15 B starting Oct 1st
Oct meet: Cut $10 B to $5 B starting Nov 1st
Dec meet: Cut $5 B to zero QE starting Jan 1st
That would mean QE would not end until December 31st. Fisher said he would like to see it end in October and that upset the market. If they cut the remaining $15 billion at the October meeting then QE would end with the October purchases.
Personally I don't think it matters whether QE ends on October 31st or December 31st. Fisher also made the point that QE has run its course and continued purchases has no impact on the markets. He took the opportunity to slam the new forward guidance given by Yellen as a "new fad" taken up by the Fed. Yellen dropped the 6.5% unemployment rate threshold as expected and discussed a much broader range of factors that the Fed would use to determine monetary policy. Minneapolis Fed President Kocherlakota also blasted the new guidance on Friday saying the Fed is not being specific enough to give the markets confidence in the timing of future rate increases. He is pushing for an unemployment threshold of 5.5% and not more than 2.25% on inflation.
Yellen also knocked the markets for a loss when she defined the "considerable period" phrase used in the Fed statement as about six months. In prior years early in the last decade that term meant 10-12 months based on when the Fed took action after using that phrase. SF Fed President James Bullard said on Friday the surveys from the private sector had been assuming six months so the Yellen comment was not a big revelation.
The market is upset because every time a Fed head speaks it seems to pull the eventual date for raising interest rates another month or two closer. Pretty soon it will be in early 2015 if the pace of advances continues. If QE ended on Oct 31st then six months means rate increases could be as soon as April 2015. I don't think that is what the Fed is targeting and I would expect a lot of position shifting in the coming months to push expectations back into the distant future.
The triple shot of Fed speakers knocked the markets back into a negative trend by 1:PM and there was a sizeable amount of stock for sale on the NYSE ahead of the close. Much of that came from option expiration squaring of positions and the rebalance of the S&P. Quite a few stocks have repurchased so many shares that their weighting in the S&P is skewed. S&P reweights the index at the last expiration day in the quarter.
There were no economic reports to distract the market on Friday and that allowed all the headlines from the Fed speakers to drive the market.
Next week has a lot of reports but none of them are really market movers. The Richmond Fed Manufacturing Survey on Tuesday is of moderate interest but rarely a market mover. The GDP on Thursday is the last revision of the Q4 number. Analysts are expecting a small uptick from 2.38% growth to 2.6% but it will be ignored unless the number is dramatically different from expectations.
I have said several times that China's slowing economy is more important to the U.S. markets than Crimea. The HSBC Manufacturing PMI for China fell to 48.5 in February and a seven-month low. This weekend they will release the March PMI and some analysts believe it could fall further.
President Obama is going to Europe this week for a G7 meeting where they will discuss sanctions against Russia and a G20 meeting where they will discuss keeping nuclear material out of the hands of terrorists. The G7 (Canada, France, Germany, Italy, Japan, UK and US) have cancelled all future plans for G8 meetings, which included Russia in that list.
Russia said it may have to cancel a sale of $7 billion in bonds after both S&P and Fitch changed their outlook on Russia to negative citing the impact of a slowing economy due to Western sanctions. Both companies kept their ratings at BBB, the second lowest investment grade. Fitch said U.S. and EU banks will be reluctant to lend to Russia and the private sector is going to need government support from a lack of lending. Growth had already slowed to 1.3% in 2013 and investment is contracting.
Russian Deputy Foreign Minister, Sergei Ryabkov said Russia did not want to use the Iranian nuclear talks to "raise the stakes" but they may have to do so in response to the actions by the US and Europe. There is never a dull moment in this high stakes game of Risk.
The meetings of the 6 nation UN team with Iran began again last week and if Russia suddenly decides to side with Iran the fight to keep Iran from making nuclear weapons is going to take a turn for the worse.
There are also worries about space cooperation with Russia. Since the space shuttle missions ended the U.S. pays $150 million per seat for Russia to send our astronauts to the International Space Station. Are they going to continue taking our money or put us on the no fly list?
Also, the monster Saturn 5 rockets we use to put our satellites into orbit uses Russian engines. Who knew? The space agency said they have enough in inventory for several more launches but they are afraid Russia will halt delivery of future engines until the sanctions are lifted. The space agency said they were going to review the launch list and prioritize which satellites would be allocated the remaining Russian rockets. Russia will have to decide if they want to continue letting the U.S. send up spy satellites on Russian engines or cancel the deal and lose the money.
Visa (V) and MasterCard (MA) have stopped accepting transactions from customers of Russia's Bank Rossiya. The bank's main shareholders, Boris and Arkady Rotenberg were the target of U.S. and EU sanctions. This is Russia's 15th largest bank with $12 billion in assets as a "personal bank for senior officials of the Russian Federation." Customers of another Russian bank, SMP, also found their credit and debit cards had quit working without any prior notice. This cuts customers off from global ATMs and anywhere Visa and Mastercard are accepted. Putin joked about SMP being just an average bank. He said he did not have an account there but promised to open one on Monday morning.
Exxon (XOM), GE and Boeing (BA) are growing concerned that Russia could retaliate against them for sanctions levied against Russia. GE Aircraft, the world's largest aircraft lessor, has 54 planes in Russia. Boeing is worried that long term sanctions could weigh on the European economy and depress air travel and the demand for new planes. Russia is Exxon's largest exploration area and they had a request pending to Ukraine officials to drill in the Black Sea off the Crimean coast. That request will have to be resubmitted to Crimea once a new government is formed.
In the last cold war it was a lot easier. We had little to do with the Soviet Union and they had almost nothing to do with us. The current cold war is only a couple of weeks old and already there are serious repercussions even though the current sanctions are little more than a pin prick to Russia.
In other news shares of Visa and MasterCard were highly volatile after an appeals court ruled the Federal Reserve acted within its authority when it capped debit-card swipe fees at 21 cents. MasterCard shares fell -3% on the news.
Shares of Gilead Sciences (GILD) fell sharply after Democrats on the House Energy & Commerce Committee asked for a briefing from Gilead on why the hepatitis C drug Sovaldi costs $84,000 per patient. Gilead did not make a public statement but other companies immediately came to their rescue in the press. The CEO of Biogen said the drug took years to develop and years to go through the testing and approval process. More than 90% of patients taking the drug are cured. Not put into remission but cured. They no longer face lifelong liver problems that eventually lead to transplants and expensive drugs for the rest of their life. You take Sovaldi and you are cured. While $84,000 is a lot of money I suspect it is cheaper and far more painless than the lifelong alternatives and Gilead deserves to make a profit so they can invest the money into developing new drugs that save lives. If drug companies are prohibited from making a profit on life saving drugs they will quit developing them. It is a business not a charity.
Gilead shares fell more than -4% to decline below strong support. I view any further dip as a buying opportunity.
Endocyte (ECYT) said its experimental cancer drug vintafolide, when used in combination with another approved treatment, improved survival rates without the disease worsening in patients with recurrent lung cancer. In a test of 199 patients that had already failed at least one prior treatment of chemotherapy the risk of worsening or death was reduced by 25% compared to patients without the drug. Shares of Endocyte rallied +92% on the news.
Shares of Ann Inc (ANN) spiked +$5 after Golden Gate Capital disclosed it had purchased a 9.5% stake in the retailer. In a letter to management Golden Gate said it believed the shares were undervalued and it thought the retailer was "well-managed" and it looked forward to helping the company boost its share price. Golden Gate is now the largest shareholder. ANN posted strong earnings just a week ago that were much better than its competitors.
Symantec (SYMC) shareholders woke up to a nightmare with shares falling -13% after the CEO was unexpectedly fired. CEO Steve Bennett was terminated by the board as "the result of an ongoing deliberative process and not precipitated by any event or impropriety" according to the statement by Symantec. FBR analyst Daniel Ives called the news "jaw dropping." The termination came after Symantec forecasts for the current quarter came in below analyst's expectations. The board said Bennett was not reviving the company fast enough.
Lions Gate Entertainment (LGF) continued its downward trend as the next teen trilogy movie opened at the box office. Divergent is the name of the first of three books featuring teen warriors and romances set in a future USA by author Veronica Roth. The books had sold 18 million copies. This is similar to the Hunger Games trilogy also from Lions Gate.
The company said tickets for early bird showings on Thursday night totaled about $5 million and they expected a $50-$65 million box office for the weekend. On the strength of the Thursday opening the company said it had green lighted the first sequel "Insurgent" to open in March 2015 with the third sequel to open in March 2016.
However, about ten days ago the early reviews began to flow and they were not kind. The critical reviews beat up the movie on multiple points but their Twilight trilogy suffered the same fate and went on to break box office records for Lions Gate. The key here is that teenagers don't read reviews and movies focused on teenage girls are not really understood by mostly middle aged male reviewers. Critics gave the movie a 39% approval rating while moviegoers on Thursday night gave it a 79% rating. Twilight saw 49% and 73% respectively.
I admit I agreed to go to the first showing on Thursday with my wife, a teen at heart, and it was better than I expected. Based on the reviews I was expecting the worst. There was plenty of audience participation with teenage moans in the romantic scenes and cheers in the dramatic scenes and applause at the end. I will be looking forward to the sequel simply because the original was better than I expected and there was the mandatory cliff hanger at the end.
Shares of LGF have not responded well to prior movie openings. Shares tend to run up ahead of the opening but then crater in the days immediately preceding the event. This opening was no different with shares falling to a nine-month low.
Much of the Dow's decline on Friday came from a -5% drop in Dow component Nike (NKE). The company reported earnings of 76 cents compared to estimates of 72 cents. However, the company warned that foreign exchange headwinds would significantly drag on earnings growth into 2015. The company predicted earnings growth would be in the mid-single digits compared to analyst expectations for +12% growth.
Nike gets 45% of its revenue from outside the U.S. and currencies have been volatile. The company said sales in China could be flat or even decline. In early 2012 Nike was projecting $4 billion in sales in China. Fast forward to today and they had five quarters of sales declined with only a gain of 7% last quarter. Now they are predicting weakness again. I read one article last month claiming they have over 100 competitors in China making knockoffs of their shoes. The Chinese government is very weak on patent protection and it only takes the smallest in manufacturing deviations for the government to say it is not a copy. Nike's $4 drop accounted for more than 30 points of Dow decline.
Anadarko Petroleum (APC) won another battle in the Deepwater Horizon liability trial. After reviewing the facts the judge in the case ruled in favor of Anadarko for the third time claiming the company had no culpability in causing the oil spill. Anadarko was a 25% owner in the well but as a passive investor had zero control in the well. Anadarko had sent BP some emails asking BP to drill deeper but BP declined. Anadarko believed there were other deposits slightly below the well's total depth. In other documents engineers pointed out problems with BP's operation and recommended that APC not partner with BP in the future. The next portion of the liability trial will begin in 2015 and after today's ruling no evidence of Anadarko's alleged liability will be allowed during the penalty portion of the trial. This was a win for Anadarko because the liability penalty could be over $17 billion for BP.
Lockheed Martin (LMT) shares fell -2.53 in regular trading and continued lower after the bell on a report that the software for the F-35 fighter will be delayed for 13 additional months. "Persistent software problems" have slowed testing to demonstrate the aircraft's combat, navigation, targeting and reconnaissance systems according to the US Government Accountability Office. The marine Corp version was supposed to be deemed combat ready by mid-2015 and now it could be delayed for up to 13 months. This delay in the Marine version will also push back acceptance by the Air Force and Navy models. The Air Force model was supposed to be ready by mid 2016 and the Navy model by mid 2018.
However, Lockheed said they had not yet seen the GAO report and were still confident the Marine version would be ready by July 2015. Lockheed was supposed to have 27% of the software completed by January and only had 13%. The F35 program budget is projected to be $391.2 billion for an eventual fleet of 2,443 F-35s. That is 68% higher than the budget estimate in 2001 and the number of aircraft has been cut by -401 planes. Full production is not expected until 2019. Shares of LMT fell another -$1.25 in afterhours trading.
It was a really ugly day for the biotech and pharma sector. The biotech ETF (BBH) fell -5% after three weeks of already steep declines. Friday's drop was blamed on the letter to Gilead Sciences but it was actually the punctuation on a long sell off. Several analysts speculated that Friday's drop was the result of a major player dumping the biotech ETF. Volume in the ETF was 434,000 shares compared to only 56,000 on Thursday. Of course the $64 question is whether the selling in the ETF crushed the shares or the selling in the shares crushed the ETF? I suspect it was the ETF selling that crushed the sector because the damage was widespread. It was not just a couple stocks with losses but all biotech and pharma stocks were sold hard.
Is it safe to buy the dip in this sector? The ETF fell back to support at $94 with longer term support at the 100-day at $92. Typically when there is a major sustained drop in a sector for whatever reason the indexes tend to overshoot the actual support level. That means we could get another big day of declines that pushes the ETF through the 100-day level as thousands of investors cover margin calls on Monday. These stocks have been the momentum leaders in the market and momentum up often converts to momentum on the downside as well. We have definitely seen that over the last three weeks. If we see support at either level hold for a couple days I would begin to nibble at these stocks again.
The Dow and S&P have been down the last week in March in 17 out of the last 24 years according to the Stock Trader's Almanac. End of quarter portfolio rebalancing takes the blame for the declines. The average decline is -1.6%. While there is no guarantee historical trends will continue there is a 71% chance this could be a down year.
In mid-term election years the next six months are typically very volatile and tend to be negative. The market tends to peak in late April and decline until the elections. That is not a straight line drop but a period of overall weakness. The average decline over the next six months in a mid-term year is -2.5% but there have been a lot of double digit declines since 1950. In the seven mid-term years starting with 1986 there have been four declines averaging a -9.4% drop. There have been three positive years with an average gain of +4.3%. April is historically bullish followed by the six worst months in the market starting in May.
The S&P rallied to a new intraday high at 1,883.97, call it 1,884, before rolling over on option expiration, rebalancing and comments from Fed heads. Some analysts cautioned the sharp drop from the new highs was a bearish signal of a potential short term market top. Others just pointed to the news flow and said "don't worry, be happy" buy the dip.
In researching for the market commentary and plays in the various newsletters I normally look at 500-700 charts a weekend. On Friday I noticed a lot of very bearish charts. I would say 75% or more were short term bearish and at least 50% were longer term bearish. It was a frustrating exercise.
However, just because a stock has returned to short term support does not mean it is about to implode. It just means traders are taking profits and the market is proceeding in normal cycles. It is when that initial support fails that sentiment will change dramatically. Quite a few charts were at or below that point. I also tend to look at the momentum names so I expect volatility and overshooting of initial support. I am not ready to put on my bear coat yet but we could be close if the market does not improve quickly.
It is hard to caution everyone about an underlying weakness in the market when the indexes are making new highs but despite the bullish sentiment we need to keep watching for weakness around the edges. The number of stocks over their 50-day average is declining and could be on the verge of a significant drop. The 50-day is a short term average so that is our early warning indicator. As of Friday 75.4% of the S&P 500 stocks were still over their 50-day.
The immediate stop at the new high resistance is troubling but it was a quadruple witching expiration. There was huge volume at the open and at the close. There were 9.7 billion shares traded in total. Other than the Nasdaq the index declines were minimal. The Dow lost -28, S&P -5, Russell 2000 -5 and Nasdaq -42 thanks to the biotech decline. That is hardly a bearish day.
The S&P is still well above critical support at 1,840 and at the higher end of its recent range. It is too early to be crying wolf and loading up on short positions. Resistance is now 1,883 and the April target is 1,900. I would be a put buyer with a print on the S&P at 1,898 for the sell in May cycle. I like to get in a couple points early.
The Dow decline was mostly due to the -$4 drop in Nike and -$2 in Goldman Sachs. The rest of the 30 stocks were evenly distributed and no real trend visible. However, Friday's high was another in a series of lower highs since early January. Resistance at 16,450 appears solid and the Dow has been lagging the rest of the indexes. I looked at the individual charts for the Dow 30 and 15 of them had negative trends and 15 had positive trends so basically a draw. The change in sentiment for Nike could be a determining factor. If Nike continues to decline it could tip the balance of power.
For next week the MACD and RSI are neutral after an early week rebound. I would continue to watch the 16,200 level as initial support and the 16,450 level as initial resistance.
The Nasdaq was dragged lower by the implosion in the biotech sector. Biotechs and high flying tech stocks like Amazon, Netflix and Google were the biggest losers. It definitely looked like institutional investors were closing out some rather large positions. Art Cashin reported a large order imbalance to the sell side all day long. The S&P rebalance was responsible for a lot of that as some stocks had their S&P weightings reduced by 3-4% as a result of buybacks and that is huge.
The key to the market next week could rest on the Nasdaq performance on Monday and Tuesday. If the selling climaxed on Friday because of expiration and rebalancing then the tech index could rebound early in the week. I don't want to pin all my hopes on Monday because margin call selling and leftovers from expiration and rebalancing could continue to weigh on the Nasdaq on Monday. Tuesday's performance would be the key.
Resistance appears to be 4,340 and support at 4,245. Nasdaq futures actually rose slightly after the close and that is a good sign.
On the long term weekly chart you should note the bearish divergence of the MACD. The Nasdaq is at 14 year highs but the MACD is turning bearish.
The Russell 2000 hit an intraday high of 1,208 and that is exactly the historic closing high. It should have sold off on the first retest of that high. The -5 point loss was minimal and it closed above initial support at 1,190. I don't think the Russell is giving us any negative signals at this point. There are a lot of biotechs in the Russell 2000 so there was an anchor preventing it from moving higher.
Resistance will remain 1,208 and the intraday high at 1,213. Support is 1,190 and 1,175.
I am neutral for next week given the weak seasonal record. I am positive for April. I think the weather excuse is a get out of jail free card and will be used frequently by everyone whether they need it or not. Companies can unload some accounting baggage into the quarter and blame it on the weather.
Fed Ex CEO Fred Smith said last week this was the worst winter ever for his company. This was especially true in January and February. There were about 20 storms in all that cost FDX about $1.4 million per day in terms of overtime, deicing, snow removal, "purchased transportation" and missed deliveries. The polar vortex delayed about 40,000 express packages per day along with 100,000 ground shipments. In all FedEx said the storms cost them $125 million in lost profit.
The comments from Smith gave every single company to report Q1 earnings the perfect excuse for missing their numbers. That means the April earnings cycle should be relatively calm and companies blaming the weather should not be punished severely. The markets should move higher as the month progresses.
On Friday the Turkish government blocked access to Twitter for 74 million users. They blocked Twitter to keep citizens from accessing documentation posted online showing past corruption and payoffs to Prime Minister Erdogan and others running for reelection. Enterprising Turks started posting ways to get around the ban as graffiti on bus stops and any flat space available. Turkey then blocked DNS from Google to prevent citizens from using the Internet to search for the documents. Of course the geek crowd immediately created workarounds to bypass that block. Now citizens have turned to Facebook, YouTube and dozens of other forms of social media to get the information.
If Erdogan did not have enough angry citizens to vote him out before the blocks he definitely does now. The protest against him as exploded as people not interested in the documentation found their internet access seriously degraded by his attempts to keep it secret. Now everyone with a computer or smartphone is really ticked off. Unfortunately they can't control the potential for bogus election results so the outcome will not be known for several more weeks.
Enter passively and exit aggressively!
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"The four horsemen of the Investment Apocalypse are fear, greed, hope and ignorance. And notice, only one of the four is not an emotion â€“ ignorance. These four things have accounted for more losses in the market than any recession or depression, and they will never change. Even if you correct ignorance, the other three will get you every time."
James P. O'Shaughnessy