Trade talks have come to a halt and hostile headlines are increasing.
The market rebounded from a 204-point drop at Friday's open to +94 gain at 11:00. The futures were down hard over worries about China trade talks. News that President Trump was likely to push off a tariff decision on autos from the EU and other countries until November, helped diffuse some of the tension. Later in the morning there were rumors the steel and aluminum tariffs against Canada and Mexico would be lifted. These rumors allowed the Dow to rebound nearly 300 points from the lows.
Unfortunately, late in the day news broke there were no further talks scheduled. Hostile headlines were increasing from both sides and suggesting it could be a long time before talks resumed or made any progress. China was calling the US "insincere" and said President Trump was trying to "bully" China. President Trump tweeted that China was not negotiating in good faith and had broken prior agreements on points that put the talks back to the beginning. The Chinese government has suddenly shifted to a nationalism stance. On Saturday they preempted regular TV to run two documentary specials touting the Chinese fighting against the US in the Korean War. China abruptly cancelled purchases of 3,247 tons of American pork.
Before talks can be rescheduled, they first must agree on what to discuss. China has reportedly refused to discuss the points where the prior agreement had changed. They are clearly trying to buy time until they can gauge the outcome of the election. If it appears Trump is going to win again, they will probably come back to the table. If it appears someone else is going to win, they will endure the pain and wait out the election in hopes of getting a better deal with the new president.
The market was not happy with these revelations. Instead of a quick fix and back to the table with conditions as before, it looks like months of negative headlines and contentious meetings lay ahead. On Saturday White House officials tried to calm tensions saying talks could resume in 4-5 weeks. There have also been comments that President Trump would meet President Xi at the June 20th G20 meeting, but Chinese officials rebutted that saying there was no scheduled meeting between the two.
The bottom line is that the trade war is ramping up and there is nothing on the horizon for traders to focus on as a solution.
One factor influencing trade decisions is the sharp drop in the value of the Chinese yuan. The chart compares the Yuan to the dollar and 7:1 is a critical historical level. On this chart, higher is bad because it takes more yuan to buy a dollar. The currency fell so sharply over the last two weeks some analysts believe China has removed the supports and is letting the currency decline to offset the impact of the tariffs. A dollar will buy more goods priced in yuan which effectively means Chinese goods are on sale. Analysts were afraid China would lower the value of their currency to offset the tariffs and it appears to be happening whether the Chinese government is a motivator or not.
The US dollar rallied back to 98 on the Dollar Index and close to the two-year highs from April. The rising dollar compared to the falling yuan is going to be a benefit for China. Stronger dollars buy more yuan denominated goods. Unfortunately, it means less sales of dollar denominated goods to other nations. It makes our goods more expensive. This will be a serious headwind for Q2 earnings. Walmart said they would lose $1 billion in Q2 sales because of the strong dollar.
Consumer sentiment spiked more than 5 points to 102.4 in May. That is the highest level since January 2004. The present conditions component rose only fractionally from 112.3 to 112.4 but the expectations component spiked 9 points from 87.4 to 96.0 and a 15-year high. This survey was prior to the recent trade war conflict and the numbers are likely to decline sharply in the late month revision.
The strong job market is supporting sentiment and that shows no signs of ending. Jobs are plentiful, wages are rising and unemployment is at a 60 year low. The equity market was testing new highs when this survey was done.
The Conference Board's leading indicator report showed a +0.2% rise in April after similar gains in the prior two months. Employment, unemployment claims, retail sales, new manufacturing orders and equity prices all contributed to the rise. The steady gains suggest the economy is healthy and growing.
However, the Atlanta Fed real time GDPNow forecast for Q2 took a sudden turn for the worse on Wednesday when the retail sales for April fell unexpectedly by -0.2% from a +1.6% rise in March. The hit to sales came from building materials with a -1.9% drop due to the unseasonably cold wet weather seen on both coasts in April. This limited construction and remodeling activity to indoors. Electronics fell -1.3%. Gasoline stations rose 1.8% because of the rise in oil prices.
The hit from building materials will reverse in May as warmer weather arrived.
There is just enough weakness in the economic reports along with the trade disaster to cause the Fed funds futures to completely price out a rate hike through January. There is only a 21.6% chance that rates will not be lower by year end. There is a 37% chance of two cuts and 76% chance of one rate cut before the end of 2019.
We have a very skinny economic calendar for next week with only two home sales reports and two regional Fed reports. The highlight will be the FOMC minutes on Wednesday. Analysts do not expect to find any undiscovered nuggets of wisdom regarding future rate cuts, but they will be looking. Given the futures forecast, they may be looking even harder than normal.
Dow component Home Depot reports earnings on Tuesday and quite a few analysts expect a miss and possibly lower guidance because of the weather-related weakness in building materials. Lowe's will follow up on Wednesday. Target will try to pull out of its dive when it reports on Wednesday. Shares have been in crash mode since Amazon announced one-day delivery to Prime members.
The Hewlett Packard twins will both report on Thursday and nobody expects any surprises. PC sales are down according to Gartner Group and enterprise cloud is becoming a crowded battleground.
Autodesk would be my favorite for the week. The stock has been very volatile of late and there should be a big move after they report. Autodesk and Adobe are the kings of the software as a service space.
460 S&P companies have reported earnings with a projected Q1 rate of 1.4% growth. This is significantly above the -2% decline forecast at the most bearish phase of this cycle. Some 75% of companies have beaten on earnings and 57% have beaten on revenue with a 5.6% projected growth rate for revenue. The projected growth rate for earnings in Q2 is 1.1% followed by 1.8% in Q3 and 8.1% in Q4. Revenue is expected to average about 4.5% across all three quarters. There have been 55 earnings warnings for Q2 and 17 companies issued positive guidance.
The three big events for last week included Cisco Systems, Walmart and Nvidia. Dow component Cisco reported earnings of 78 cents that beat estimates for 77 cents. Revenue of $13 billion rose 6% and beat estimates for $12.89 billion. For the current quarter they guided for earnings of 81 cents, in line with estimates. They guided for 5.5% revenue growth which beat estimates for 3.5%. As Cisco broadens its offerings from simply hardware to software and managed services it has become less dependent on the hardware cycles. The upgrade to 5G is expected to power an entirely new wave of data traffic and that will require larger and faster network equipment. Cisco said this would benefit sales of their Catalyst 9000 series of switches in future quarters. Shares spiked $4 on the news.
Dow component Walmart (WMT) reported earnings of $1.13 that easily beat estimates for $1.02. However, revenues rose only 1% to $123.925 billion and missed estimates for $124.51 billion. Excluding the impact from currencies they would have reported $125.8 billion. The company warned that currency issues would cost them about $1 billion in sales in Q2.
Same store sales rose 3.4% but e-commerce revenues rose 37%. That was down from 43% in the holiday quarter. They are definitely taking the battle to Amazon. Earlier in the week Walmart announced a free next day delivery service to combat the service from Amazon. Walmart will offer 220,000 frequently purchased items for next day delivery and buyers will not have to be members if the sale is over $35. They expect the service to be operational in 75% of the country by the end of the year.
Nvidia (NVDA) reported earnings of 88 cents that beat estimates for 81 cents. Revenue of $2.22 billion narrowly beat estimates for $2.196 billion. While they beat on both metrics that was a 30% decline in earnings on a 57% decline in revenue. They said they were working through excess inventory and the company was finally back on an upward trajectory. They guided for Q2 revenue in the range of $2.55 billion "plus or minus 2%." Analysts expected $2.537 billion. However, the chipmaker said they would no longer provide full year guidance because "visibility remains low." They will continue to supply current quarter guidance. They admitted a slowdown in the data-center market is not improving and the recovery cannot be forecast.
They said trade tensions with China would not prevent the acquisition of Mellanox (MLNX). This company provides the connections between multiple AI computers to create monster AI networks.
Nvidia shares rose 7% in the afterhours session until they announced the end of annual guidance and refused to affirm prior guidance due to the data-center weakness. Analysts are worried that the massive cloud buildout of the last several years has peaked. Shares collapsed to lose $3.66 for the day on Friday.
Readers know that I am always positive on Nvidia because I understand the impact their technology is having on the future. They may actually be too far advanced and the rest of the technology sector has not yet caught up enough to generate higher demand. They are so high performance that only the largest and most technically advanced applications can get full use out of their chips. They still make high performance video cards for gaming PCs but the move to browser-based gaming where PCs do not need high performance video cards, could dent demand on that level. Their cards will still be in demand for high performance workstations or CAD development but that is a much smaller niche. The chip sector is in decline because of warnings from several chip makers. Nvidia is declining with the sector. I would look to pick up some Nvidia shares or LEAPS around $140.
Applied Materials (AMAT) reported earnings of $70 cents that beat estimates for 66 cents. Revenue of $3.54 billion, fell $1 billion but beat estimates for $3.50 billion. They guided for current quarter earnings of 67-75 cents and analysts were expecting 70 cents. Revenue guidance of $3.67 billion beat estimates for $3.5 billion.
The company said capital spending on wafer equipment would decline in 2019 but they expected business to rebound in 2020. Competitors KLA Tencor (KLAC) and Lam Research (LRCX) both gave similar guidance for 2019 and 2020. Applied Materials said they expect "good growth" in 2020. They said chip complexity is slowly rising and it takes more equipment to produce each succeeding version of a chip, especially DRAM and NAND memory. AMAT shares posted a decent gain on Friday despite a big decline in the Semiconductor Index.
Beyond Meat (BYND) shares finally took a breather after a surging to $90 from its IPO price of $25. The stock cooled after noted short seller Citron Research tweeted that Beyond Meat had become Beyond Stupid and should decline $30% from Thursday's close. In a tweet Citron said the market cap of Beyond now exceeded that of the entire industry. As of Friday's close the company has a $5 billion market cap and is expected to report only $40 million in sales for the quarter. They are also expected to post a 15-cent loss. They are trading at 31 times expected annual sales and they are a food company. A sector that normally trades in single digit multiples. They do have a good product that is likely to take market share from competitors and the meat industry BUT it is going to take a long time.
Options have begun trading, but the cost is prohibitive. With BYND at $90, the June, front month, $85 put is $10.20. The next available month is August and the same put is $19.80. This is crazy and it will fade.
Elon Musk sent a memo to employees saying the company only had 10 months of cash at the Q1 burn rate and he was going on a "hard core" cost cutting program. Tesla just raised $920 million in a bond sale in March to bring their cash balance up to $2.2 billion. That is a lot of money unless your cash burn rate is $3 billion a year.
Tesla may be flaming out. With 17 different EV models being released by competitors over the next 24 months, Tesla is no longer the only game in town. Other companies are not having delivery problems and their cars are sold in showrooms alongside gasoline powered cars. Every dealer is also a repair shop and there are no waits for multiple weeks for repairs and parts. Tesla demand is slowing and along with it cash flow is slowing.
Musk has blown his chance at being the leading EV manufacturer in a high-volume industry. Everybody knows he is an innovator but using his own words he sucks at being an auto manufacturer. With the potential to run out of cash ten months from now there will either be another massive capital raise, which may not go well, or he is going to be forced to look for deep pocket investors like his friends in Saudi Arabia. I would not be surprised to see Tesla acquired over the next couple of years. So when will the semi-truck, pickup and Model Y SUV become available? Don't forget the $250,000 Roadster with 0-60 in 1.9 seconds, 250 mph and 620-mile range. It was announced in November 2017 and I would not expect to see that in the near future. Full payment in advance to confirm reservation.
Musk said he was going to aggressively cut costs. Maybe he should start with his $530 million compensation package the board gave him. I believe we are going to see shares below $200 very soon. The October 2016 low was $180. That is the current target and a breakdown there would target $150. The bloom is definitely off this rose.
Lukin Coffee (LK) is a fast-rising competitor to Starbucks in China. The company is less than two years old and has 2,400 locations with plans to reach 5,000 locations in 2019. These are small format stores with very little seating. They do not accept cash. All orders are made and paid through an app. The drinks are highly discounted through coupons served through the app. One reporter said she got 14 coupons when she registered for the app. The discounts allowed her to buy a latte for the discounted price of 69 cents rather than the $4 Starbucks charges. The concept is for busy Chinese shoppers and business people to order a drink and pick it up in a takeout container. They also offer a lot of flavored teas, which is still the staple drink in China.
They priced their IPO at $17 and shares spiked to $26 at the open. They faded to $20 at the close in a negative market.
Uber shares recovered from the $9 post IPO plunge but now that options have begun trading, we could see a longer-term trend appear. Unlike BYND the options on Uber are reasonable for a June $40 put at $2.05 with UBER shares at $41.91. Nothing has changed since last week. The company is still losing billions of dollars and their only way to boost revenue is to raise prices and cut driver pay. That is a recipe for disaster, but it is the only one they have. While they may succeed in offering additional services like Uber Freight, they are a long way from making money on it. I look for Uber to retest its lows soon.
Apple (AAPL) shares are holding just above $185 and $30 below their high for May at $215. The China trade disaster is weighing on Apple shares. Their market share in China is falling. The nationalism against American companies is rising. The import tariff on Chinese made iPhones rose from 10% to 25% on May 10th. The impact is estimated to be as much as $160 per phone. With the summer doldrums ahead and six more weeks of China trade headlines, we could easily see Apple retest $175. Nomura agrees with my outlook and cut their price target to $175 on Friday. They said tariffs could cut Apple's earnings by 20%. Apple would have to raise prices in the US by 17% to recover the 25% tariff. With iPhones already at the upper bound on US pricing they do not have room to raise prices close to $1,300. The market will not support it.
Oil prices were relatively calm last week despite the Iranian headlines. There was a minor bounce on Thursday but faded slightly on Friday. Contrary to historical trends inventories are not declining and refinery utilization just barely broke 90% for the second time this year. We should be approaching 95% only two weeks before Memorial Day and prices should be rising.
Active rigs declined -1 with oil rigs falling -3 and gas rigs gaining one. All quiet in the energy sector.
Drilled but uncompleted (DUC) wells declined by 43 in April but remain at record levels. There is no reason for producers to drill lots of new wells when their backlog remains so high. That is why the rig count has been in decline.
Whenever there is a big decline, we should always expect a material rebound before another decline to lower lows. Those investors looking for a buying opportunity see the first decline and buy the dip. Seeing the rebound, shorts are forced to cover. Normally after a couple days the rebound falters for lack of volume and the shorts become brave again and begin selling stock. Prior holders who did not want to take a big loss on the first decline have had time to reconsider market direction and begin to unload when the rebound fizzles out.
Obviously, I could describe that scenario in a variety of ways but that is the most likely outcome of our present situation. I believe we are in the "eye of the storm" and future headlines or lack thereof will lead to another decline to lower lows. The fury of the first crash has passed and last week was rather tame. Resistance was met on Thursday and Friday saw traders moving to the exits on negative trade news.
While the president will try to put some lipstick on the trade pig, it is still a stinky pig and until a positive outcome is seen forming, the market should react negatively.
Add to that the sell in May trend and the beginning of the summer doldrums on June 1st. Schools will be out, family vacations will be starting and investors will be focused elsewhere. Nobody wants to go on vacation with a portfolio full of longs when the geopolitical situation is so negative.
The S&P has multiple levels of strong resistance from 2,868 through 2,900. The index has failed at 2,885 on each of the last two days. The obligatory rebound has occurred and we could be in the process of rolling over. Support is 2,800 and 2,776 and the 200-day.
The Dow dropped to the 100-day average where it tested that level on three consecutive days. Thursday's gap open propelled it to resistance at 25,950 where it failed on Thursday and Friday. The 50-day is 26,066 with resistance from late 2018 at 25,826. There are multiple resistance levels from where we are now to the very strong resistance at 26,616. We are not likely to suddenly charge higher and bust through all those levels.
The Nasdaq performed a perfect rebound from support at 7,645 and surged to resistance at 7,945. On Friday the index tried to return to that resistance and failed. The Nasdaq closed back below the 50-day and presents a perfect picture of a normal bear market rebound. The big caps normally supporting a rally were seriously negative on Friday. The falling chip stocks were dragging the tech sector lower.
The key question this weekend is "would you buy this chart?" Since the small caps normally lead the broader market and they closed just above the 7-week low from Monday, the path of least resistance is down. The 200-day average was solid resistance over the last two days. The odds are good the Russell is going to break below the 100-day and retest 1,500. That is the critical line in the sand.
While I am bearish on the market, that outlook and $4 will only buy you a bad cup of coffee at Starbucks. Nobody knows where the market is going but the negative geopolitical events seem to be growing. At any time, we are only one tweet away from a major rally or a major crash. With most of the macro issues pointing to further weakness I would recommend buying the dips only for trading positions. We could get lucky and have a tweet or White House headline predict a swift resolution but until you hear that from a Chinese official, I would have a hard time believing it. Expect continued weakness and be thankful if a rally appears.
Enter passively and exit aggressively!
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