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Daily Newsletter, Tuesday, 3/19/2019

Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews

Market Wrap

Complacency Check

by Jim Brown

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Investor sentiment was blindsided with a wakeup call on China.

Market Statistics

The Dow opened sharply higher with Boeing up more than $6 to add roughly 42 points to the Dow. The S&P was surging with a 20-point gain and the future looked bright. That is when reality struck in the form of conflicting headlines suggesting the Chinese trade talks had hit a rough patch. The Dow immediately dropped nearly 200 points as the conflicting reports were debated. Late in the afternoon, cautious traders began exiting and the Dow traded down -95 points after being up nearly 200 at lunch time. While this may be just a knee jerk reaction to some unexpectedly disruptive comments, we have known this could be a real problem since early February. The stream of positive comments in February and early March had been fading with both sides using more qualified sentence structure. President Trump had backed off his positive tone saying, "not sure we are going to get a deal" despite "concrete progress" while others were stressing the problem areas in the negotiations. Hitting a road block was always a potential problem.

To summarize the comments today, China does not trust the US to remove all the tariffs after a deal is signed and the US does not trust China to actually follow through on any agreement." While that distrust is to be expected, we have come a long way only to have that problem erupt at this late date.

Reportedly the US delegation will travel to China in the coming days to continue the negotiations. When they return the Chinese delegation will come to the US to continue negotiations. As long as they are still meeting there is a good chance for success. China needs this deal a lot more than the US needs a deal with China.


Market volatility was at a 5-month low this morning, but the trade headlines spiked it again. Complacency was settling in, but uncertainty is back.


The Russell spiked 6 points at the open but selling appeared almost immediately. The intraday volatility in the Russell is increasing and similar to what is seen at market tops and bottoms. I seriously doubt this is a market bottom. If the Russell falls back below 1,550 it would be a broader market sell signal.


There were only two economic reports for the day. The factory orders for January came in at +0.1% and the second monthly increase but below consensus estimates for +0.3%. Orders for December also rose +0.1%. Nondefense capital goods ex-aircraft rose 0.8%. Inventories rose +0.5%. Shipments for durable goods declined -0.5% and nondurables -0.2%. Overall factory orders are up 4.2% over January 2018.

Tariffs remain a major problem for the manufacturing sector. The hiccup in the China trade talks today, probably gave managers another Maalox moment.

After the bell the weekly API crude inventory report showed a decline of -2.1 million barrels. Gasoline inventories declined -2.8 million barrels and distillate inventories declined -1.6 million barrels. The refined product inventories should continue to decline as refiners deplete supplies of winter blend fuels in preparation of ramping up production of summer blend fuels.

Crude prices moved closer to $60 after the weekend OPEC meeting. The consensus was that supply needed to be further restricted by additional compliance to lift prices above $60 and maintain that level. Overall compliance with the January production cuts rose from 83% to 90% in February. Russia said it would be in compliance with the proposed cuts in April, three months late. OPEC members had pledged to cut 800,000 bpd and non-OPEC producers including Russia had pledged to cut 400,000 bpd. The next OPEC production meeting is June 25-26th so the current cuts will remain in place until then.


The calendar for Wednesday is headlined by the FOMC decision and the press conference by Chairman Powell. Nobody expects the Fed to make any changes. They could disclose their plans for their balance sheet reduction or quantitative tightening. This is the removal of QE and it will take years. Analysts expect them to pause on the QT later this year.


The big earnings for Tuesday was FedEx (FDX) and it was ugly. The company reported earnings of $3.03 and analysts were expecting $3.11. That is not the worst. Back on November 1st the expectations were for $3.84. Revenue of $17.0 billion missed estimates for $17.67 billion. The company warned in December of slowing growth and shares fell from $234 to $151. That is a serious haircut.

Today the company cut its guidance for the second time in three months saying the entire world economy is slowing. They said Brexit in Europe and tariffs in Asia were pushing the global economy into recession. They also blamed the six-days per week FedEx Ground schedule in the US and continued weakness in the international Express business, which included TNT Express, they recently acquired for $4.8 billion in 2016. The said integration costs would exceed $1.5 billion and not be completed until the end of 2020. Cyber attacks on TNT in Europe cost the company $300 million. They also blamed movement by customers to lower cost, lower margin products and lower weights per shipment.

The company guided for the full year for earnings of $15.10-$15.90 and analysts were expecting $15.97. Analysts said the lack of weaker guidance suggested the worst was over or at least they were at the bottom of their performance issues. There is a level of service that will exist regardless of whether the economy falls into recession. They did warn of continued problems from exchange rates. Shares crashed $9 in afterhours.


DSW Inc (DSW) reported earnings of $1.66 that missed estimates for $1.78. The company said that included a 12 cent write down of operations in a closed business, which in theory would have put the adjusted earnings back at $1.78. Investors did not care, they sold the stock anyway. Revenue of $843.4 million beat estimates for $840.6 million. Same store growth of 5.4% beat estimates for 4.9%. Growth in the US was 6.0%. They have acquired multiple companies over the last couple years and said they were going to change their name to Designer Brands Inc and their symbol to DBI effective April 2nd. Last year they acquired Camuto Group a shoe manufacturer that owns the rights to the Jessica Simpson footwear and handbag licenses for Lucky Brand. The company has also been adding services to their locations like nail salons. What female shopper does not want to shop for shoes, bags and get a manicure at the same time? DSW has nearly 1,000 locations. They guided for the full year for $1.80-$1.90 and analysts were expecting $1.94. For 2021 they bumped estimates to $2.65-$2.71 and analysts were expecting $2.12.


HD Supply (HDS) reported earnings of 70 cents that beat estimates for 67 cents. Revenue of $1.45 billion also beat estimates for $1.41 billion. They guided for the current quarter for earnings of 75-84 cents and revenue of $1.47-$1.52 billion. Analysts were expecting 84 cents. For the full year they expect $3.52-$3.81 in earnings and $6.30-$6.45 billion in revenue, which was in line with estimates. The company was formerly part of Home Depot but was sold to private equity groups in 2007.


Michaels (MIK) reported earnings of $1.44 that beat estimates for $1.42. Revenue of $1.789 billion narrowly beat estimates for $1.778 billion. Same store sales fell 0.4% and worse than the -0.2% analysts expected. They guided for full year earnings of $2.34-$2.46 and $5.19-$5.24 billion and analysts were expecting $2.48 and $5.246 billion. Shares rallied on the report.


Earnings on tap for Wednesday are highlighted by Micron with Dow component Nike on Thursday.


Netflix (NFLX) said no thanks to Apple's streaming video service. CEO Richard Hastings said, "We prefer to let our customers watch our content on our service." "We have chosen not to integrate with their service." Apple is expected to announce their streaming video service on March 25th. It is expected to offer content from CBS, Viacom, Lions Gate and Starz along with Apple's own original content.

Some analysts believe that was the right move for Netflix. Why help Apple's service succeed if it will eventually pull subscribers away from Netflix. Most do not believe the Apple service will be a major threat to Netflix. They believe Disney could be a bigger challenge. Netflix already has more scale than either of these companies are likely to achieve over the next several years. By remaining independent it prevents the competing services from using the original Netflix content as a draw for the competition.

Apple had the opportunity to buy Netflix many times over the years when various analysts were suggesting it. They always passed on the opportunity and I am sure they are kicking themselves constantly because of that decision. Hastings said these well-funded networks were likely to come up with some great ideas and Netflix planned on borrowing them.



Tesla shares continue to decline as the fight with the SEC increases in intensity. The SEC said the use of Twitter by Musk "borders on the ridiculous" in their motion to find Musk in contempt of court. In prior battles with the SEC Musk signed a settlement agreement that required Tesla to give advance approval of his tweets. The SEC said since the order was signed, Musk has never submitted a single tweet for approval. The judge in the case can rule at any time and should he agree with the SEC the ruling could be painful. He could be fined and/or he could be removed from the company. The judge could appoint a special master to sit on the board and monitor proceedings to make sure Musk was being appropriately controlled by the board.

Musk is complaining the settlement agreement violates his First Amendment right to free speech. The SEC claims he gave up that right when he signed the agreement. Whether or not Musk gets off with another slap on the wrist or not, the next event and you know there will be one, is going to get him in real trouble. You can't continue kicking sand in the court's face and bad mouthing the SEC without eventually paying the price.

Tesla's price hikes were supposed to go into effect today. The company said they had postponed the hikes for 48 hours because of "unusually high order volume" that prevented them from processing all the orders. They did not say how many orders that represented. A 3% hike was supposed to be implemented today. You now have until midnight Wednesday to buy a Tesla at the old price.

Tesla closed at a 5-month low.


Google (GOOGL) announced its video-game streaming platform called Stadia. This is a direct attack on the traditional video game business. Instead of having the game playing on your PC or game console with limited horsepower, the game will play in Google's cloud on massive computing platforms with only the video traveling to your PC/Console. The games will be delivered by Chrome browser or Chrome OS depending on the device. By using the power of the cloud with thousands of GPUs, it takes the load off the individual PC/Console and you no longer need a $5-$10,000 gaming computer to enjoy the new high definition games. There will be nothing to download or install. The games will always be current. Starting the game will be a simple as pressing a single button. While this will not eliminate consoles or conventional games overnight it will do so eventually. You can play the same games anytime, anywhere, any place with access to a Chrome browser. No special hardware needed. The Stadia application and controller will be available in 2019. They showed side by side demos of "Assassin's Creed Odyssey" and "Doom Eternal" in full graphics mode.



Markets

Today represents a material change in investor sentiment. The comments about China walking back some concessions and concerns over enforcement actions along with the earnings and guidance from FedEx, have caused a sharp drop in overnight futures. The S&P futures are down -8 as I type this.

These headlines are going to cause a rethinking of the investment outlook. If the entire world is falling into a recession as claimed by FedEx, that is not a positive environment for equities. If the China trade talks are breaking down as evidenced by today's comments and the continued delay in setting a meeting between Trump and Xi, then bad things are likely to happen. President Trump is likely to enact the next round of sanctions and a new trade war could erupt.

Fortunately, the China comments were disputed. There were different versions and the two groups of negotiators are still talking. There is still the potential for a negotiated agreement. It may not be for weeks or even months but there is still hope.

The slowing global economy is driven in part by the pressure on China. A trade deal solves this problem as well, to some extent. The Brexit issue is not likely to be solved over the next three months and that will continue to weigh on Europe.

The US markets rallied for ten weeks in 2019. Many stocks are at new highs and the major indexes were nearing prior highs. In a perfect world this would have happened over the next couple of weeks in anticipation of a China deal. That anticipation has evaporated. Economic hopes are evaporating. The Atlanta Fed real time GDPNow forecast is only 0.4% for Q1. That should improve now that the shutdown is over and tax returns are being delivered but "should" is not a real strategy. A lot of things that should happen never come to pass.

The S&P hit 2,852 intraday but fell back to close at 2,832 and the futures are down another 8 points. Market sentiment has fractured in the space of only a few hours. Granted it could recover just as quickly with positive China comments, but you are not going to fix the claim "the entire world is falling into recession" in just a few hours. That could have a lasting impact. Support is now 2,754 and the 200-day average. I really hope we do not see that level again soon.


The Dow was closing in on resistance at 26,191 when the headlines broke. Boeing was positive and adding about 42 Dow points. Afternoon headlines on Boeing and China erased those gains. The support at 25,800 could easily be tested again on Wednesday. If the Fed develops foot in mouth disease it could be worse. However, Fed speakers seem to be moving farther away from rate hikes because of slowing inflation, housing, global economics, etc. Powell would have to go out of his way to tank the market in his afternoon press conference.

I thought it was strange that the tariff sensitive stocks in the Dow were not the ones in negative territory. It was financials and techs losing ground.



The chip sector posted a 1.3% gain and closed at a 6-month high despite the overall market weakness. This helped keep the Nasdaq positive for the day. Amazon and Google were also powering the index higher. The Nasdaq is well over prior resistance at 7,600-7,650 but still well below the prior high at 8,109. As long as the Nasdaq continues to lead the S&P and Russell should follow. There are enough tech stocks in the Russell to keep tha tindex from imploding.




The Russell spiked 6 points at the open but began to sell off in the first five minutes. There is no excitement in the small cap space, and we are looking at a lower high with the overnight Russell futures down -5 as I type this. If the index falls back below 1,550 it could sour market sentiment even further.


I would love to see the opening dip bought on Wednesday and all the fears listed above fade into oblivion. Even if that happened, I would still be skeptical. Every brick in the wall of worry becomes a challenge when/if that wall eventually collapses. With Q1 earnings still forecast to be negative and FedEx warning tonight, I feel like investors are eventually going to wonder when they should take profits. When/If we reach that prior high at 2,930 on the S&P will there be enough catalysts remaining to take us any higher. What happens when the dog finally catches the car? Sometimes it is not pretty.

Enter passively, exit aggressively!

Jim Brown

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New Plays

Sentiment Slipping

by Jim Brown

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Editor's Note

Small caps have failed to find any traction in this post earnings period. Resistance at 1,585 held the prior two weeks and now lower resistance at 1,566 is holding. There appears to be no conviction on the part of investors. They are afraid to take lasting positions in the small cap stocks despite large caps seeing an inflow of liquidity. This is not a good sign and a break back below 1,550 could be a huge sell signal.

 

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In Play Updates and Reviews

Dead Stop

by Jim Brown

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