The yield on the ten-year treasury spiked 8.5 basis points to the highest level since 2011.

Market Statistics

In reality, a 3.08% yield is not the end of the world. It has been much higher than that about 90% of the time. It is that we are finally moving away from historic lows dating back to 1789 and the trend is changing. The downtrend in yields from 1985 has been broken and the strong economic data today suggests the Fed is going to have to increase the frequency of their rate hikes. Higher interest rates are kryptonite to the equity market.

When a cautious investor, pension fund, insurance company, etc, can get more than a 3% return in a zero risk instrument it pulls money out of equities. This is especially true when the market is at historic highs. Those investors play the long-term trend cycles and historic highs are a reason to be cautious, especially after a 9-year economic expansion.



The economic reports were strong this morning with the NY Empire Manufacturing for May coming in at 20.1 and well over consensus of 15.0. This was the second strongest reading in the last six months. The headline reading was 15.8 in April. The long-term outlook for business conditions rose from 18.3 to 31.1 to recover about half of the April losses that tanked due to the tariff headlines.

New orders nearly doubled from 9.0 to 16.0 and backorders rose from 3.7 to 5.0. The most troubling number was the rise in prices paid from 47.4 to 54.0. This is up from the mid 20s for all of Q4. This is the highest level since 2011. The prices received component rose from 20.7 to 23.0 and the highest level since 2012. This was a strong report and showed the bounce back from the tariff depression in April.


Retail Sales for April rose +0.3% and in line with consensus. However, March was revised higher from 0.6% to 0.8%. That was due to a strong gain in auto sales. Clothing sales rose 1.4%, furniture +0.8%, nonstore retailers +0.6%, building materials, food and beverages rose +0.4%. Sporting goods and bars declined -0.1% and -0.3% respectively. Unfortunately, gasoline stations rose +0.8% and will be going higher in May and June. Total sales are up 4.7% over the trailing 12 months. The weather was cooler in April suggesting the May numbers could be stronger.

The NAHB Housing Market Index for May rose slightly from 69 to 70 and slightly above the consensus for 69. The internal components were basically flat with potential buyer traffic flat at 51 for the last three months after peaking at 58 in December. The six-month outlook component was flat at 77.

March business inventories were flat with only a 0.04% rise after a 0.56% rise in February. Retail inventories were down -0.48%, wholesale inventories rose 0.34% and manufacturing inventories rose 0.25%. This is a lagging report for March and it was ignored.

After the bell, the weekly API crude inventory report showed a build of 4.854 million barrels. Expectations were for a small decline of 763,000 barrels. Gasoline inventories declined -3.369 million barrels and more than twice the -1.421 barrel decline analysts expected. Distillate inventories declined 768,000 barrels and less than the -2.2 million barrels expected. Crude prices declined 37 cents after the report.


Late this evening the Japanese GDP for Q1 was announced with a decline of -0.6%. This is the first decline after 8 quarters of economic expansion. That was the longest streak since the 12-quarter streak that ended in Q1-1989. Analysts were expecting a breakeven to a 0.2% rise but the whisper numbers were slightly negative. This is going to cause consternation in Japanese fiscal policy and that could cause ripples in the global policy. Even worse, Q4 GDP was revised down from +1.6% to +0.6%. Analysts believe the Q1 decline will be temporary unless trade policy with the U.S. becomes a problem. The S&P futures are flat and showing no material impact from the Japanese data.

The calendar for Wednesday has new residential construction and industrial production. Neither is expected to move the market. The Philly Fed Survey on Thursday could move the market if it comes in higher than expected. That would raise Fed expectations once again.


The CME FedWatch Tool is now suggesting we could see three more rate hikes by the end of the year. This is the highest probability so far as inflation appears to be rising.


The Fed is also facing a potentially sharp rise in GDP in Q2. The Atlanta Fed real time GDPNow forecast is moving steadily higher and currently at 4.1%. A recent survey of analysts puts it at 3.6%. Either one would be a major change in economic activity and the Fed needs to consider this in their rate deliberations.


Dow component Home Depot (HD) reported earnings of $2.08 that rose 19% and beat estimates for $2.06. Revenue rose 4% to $24.95 billion but missed estimates for $25.15 billion. Cost of sales rose 3.8% to $16.33 billion. Same store sales rose 4.2% globally and +3.9% in the USA. Analysts were expecting 5.6% and 5.5%. The company guided for sales to rise 6.7% for the year, up from prior guidance of 6.5%. Same store sales guidance was a 5.0% rise.

A Bloomberg analyst called it the curse of the overachievers. The company continues to outperform but analysts keep raising their estimates faster than the company can keep up. "If they grew earnings by 19% in Q1 then they should be able to do 21% in Q2, 24% in Q3, etc." Analysts are always trying to project improvement when in reality a steady 20% per quarter is outstanding.

Warm weather came later than normal in many parts of the country so consumers remained indoors and dormant. Now that warm weather has arrived, we should see an acceleration of activity in Q2. The company said there was a 15% decline in garden supplies and that correlates with the late winter weather keeping people indoors. If you exclude the garden supplies, the same store sales would have risen 6.6% and beaten estimates. They also said Q2 had started strong because of the change in seasons.

Home Depot is mostly Amazon proof and it has delivered positive same store sales growth for 28 consecutive quarters. Only twice was it lower than 4%. What else could you ask for?


Eagle Materials (EXP) reported earnings of 76 cents that missed estimates for $1.04. Revenue of $284.7 million also missed estimates for $307.8 million. Despite the weak quarter, it was a record year for earnings up 29% and revenue, which rose 14%. The company blamed wet weather in two of its major markets for a 22% decline in concrete and aggregate sales. That caused a 44% decline in earnings. Offsetting that was a 43% spike in revenue in the oil and gas fracking segment with a 59% surge in frack sand volumes. Shares dipped at the open but recovered to post a decent gain despite the earnings miss.


Boot Barn (BOOT) reported earnings of 24 cents that beat estimates for 18 cents. Revenue was $170.8 million and beat estimates for $163.6 million. The company guided for Q2 for earnings of 10-12 cents. Analysts were expecting 7 cents and $151 million. Shares rose slightly in a bad market.


Earnings on Wednesday are not very exciting. Dow component Cisco is the biggest company. Jack in the Box, Take-Two, Macy's and NetEase are the next largest.


Tesla (TSLA) is not getting any love from analysts lately. Morgan Stanley downgraded the company because of Model 3 manufacturing problems. Influential analyst Adam Jonas cut his price target to $281 from $376. Jonas said the problems ramping up production reflect a fundamental design problem and production issues will impact profitability. The contentious post earnings conference call where Musk called questions "stupid" and "boring" is coming back to haunt him. Tick off the analysts and they can dump on your stock. He has already said he made a mistake and apologized.

Late today Tesla said they were closing the Model 3 production line for 6 days to change the way they assemble the cars in an effort to speed up production. There was a leaked email this morning saying the change in production would allow them to ramp production to 3,500 a week or 500 per day. In the same email Musk said he was aiming for a "burst build" mode of 6,000 per week by the end of June. The current official target is 5,000 per week. When asked why the difference he said we expect the best but if only one supplier comes up short the entire production line grinds to a halt.


After spiking $30 from $160 to $190 in nine days, Apple is finally taking a rest. This is a major part of our market weakness because Apple is the largest component in the Nasdaq and the sixth largest component in the Dow. When Apple moves, the market moves with it.

Warren Buffett's SEC filing today confirmed he loaded up on Apple in Q1 and now has roughly $45 billion in Apple stock. This was the biggest driver of Apple's $30 run along with the surprise earnings.

It is only reasonable that Apple shares should rest after their big gain and they have declined for three days.


Buffett's filing also showed he doubled his stake in Teva Pharmaceuticals (TEVA). He raised his stake from 18.9 million shares at the end of December to 40.5 million at the end of March. He has said in the past that the company is very undervalued.



Markets

I hate to break the news but volume spiked about 700,000 shares on Tuesday to 6.66 billion. Volume the prior two days was about 5.9 billion on average. If you want to know the real market direction watch the volume. Today the declining volume was almost 2:1 over advancing volume. Actual decliners were 4,589 to 2,684 advancers so almost in line with the volume.

New highs at 207 fell to the lowest level since May 3rd. This means the breadth of the selloff was expanding. Yesterday I thought we were just going to see a minor bout of profit taking. Today, I am not so sure. Many of the stocks that sold off on Monday were positive today and many of those that were positive on Monday were negative today. That is a good sign of sector rotation and not a broad market selloff.

Confused yet? You should be because there were positive signs yesterday and some today but they are not the same signs. Investors are showing their uncertainty. The earnings parade is almost over and the results have been great. The forecast is still strong for 20-22% earnings for the rest of the year. No problem there.

The challenge is the external factors. Inflation is slowly rising. The Fed is getting anxious. Or, a better way to say that is the market is becoming anxious about the Fed. Oil prices are holding over $70 and the average tank of gas costs $12 more today than at the same time last year. With a 2-3 car family, that means $120-$180 more in gasoline costs per month. Suddenly the tax cut savings are flowing into the tank on your car. High gasoline prices, more than anything else, causes consumer sentiment to decline. That money comes right out of their pockets and takes away from any discretionary shopping they might want to do.

Companies see their profits shrink as transportations costs rise. Add in the rising interest rates and potential decline in consumer spending and suddenly the future is not as bright.

Investors read these tea leaves and try to decide where their money should be 6-12 months from now. With the sell in May season here and the summer doldrums just ahead, the market may be starting to show some cracks in its foundation just like the volcano in Hawaii. Let's hope neither of them end with a mighty explosion.

As investors, even if you have an army of analysts on your side, you can never know for sure where the market is going. Opinions are like noses, everybody has one. Today we seem to have an abundance of opinions over market direction. When in doubt, follow the market. If you try and outsmart the market by jumping in front of the expected direction, you may find yourself standing alone on the road or worse run over by the market truck. Be patient a new trend will appear. When it does, follow the trend.

The S&P dipped back to 2,700 intraday before rebounding slightly to close above the 100-day average and using it for support. This is a perfect setup for a rebound if one is going to occur. Whenever there is an extended gain, we look for a 2-3 day retracement back to a support level that was passed on the move higher. If that support level holds, a rebound should occur to a higher high. On the S&P we are looking for a move over 2,750.


The Dow is a puzzle. The index tried to punch through 25,000 and was stopped. Today, the index fell back below the 100-day BUT closed right on prior resistance/support at 24,700. In theory, this is the retracement support that could provide a rebound. Cisco reports earnings on Wednesday but not until after the close. It will be no help or hindrance to the Dow intraday. Walmart reports on Thursday and there could be some uncertainty ahead of their report because of the weakness in Home Depot sales.

We need the Dow to rebound back above the 100-day and the 25,000 level in order to build investor confidence.



The Nasdaq tried to push through resistance at 7,421 on Monday and failed. Today, every big cap tech stock posted losses although some of them were mild. The FAANG stocks were losers and that held the market down. Resistance remains 7,421 and the level we must cross to turn this chart bullish.



The Russell came within a point of a new intraday high on Monday before falling back below the key 1,609 level. Today the index declined with the rest of the market but recovered to close almost perfectly flat. This is the most positive sign I have for you today. If the small caps are not declining then the big caps are not going far. Of course that could change if the small caps join the selloff but for today, this was positive.


Despite today's loss, this is still the best start for May since 2009. May is now half over and the last two weeks tend to be choppy as vacations, kids out of school and holidays begin to take investor attention away from the market.

I am neither positive or negative today. I could make a case for a move in either direction. I would be cautious about adding longs until the Dow is over 25,000, Nasdaq over 7,421 and the Russell over 1,610. The key level on the S&P is 2,750 but it is not as clearly defined.

Be patient, a trend will eventually appear.

Enter passively, exit aggressively!

Jim Brown

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