The worst of all potential trade outcomes crashed the market last week.

Weekly Statistics

Friday Statistics

If it was not for the 530-point rebound in the Dow on Friday, it would have been a lot worse. The rebound began after Secretary Mnuchin said the Thr/Fri trade talks had been constructive and talks would continue. President Trump echoed those comments in a tweet to keep the rebound moving.

Unfortunately, the tariffs rose on Friday and the president will release his plans for the next round of tariffs on Monday. China's vice premier said late Friday evening that three things needed to occur to resolve the trade dispute. All tariffs would need to be cancelled, realistic targets set for China's purchase of US goods and the text of the deal must be "balanced" to ensure the "dignity" of both nations. US negotiators then told China's team they have one month to complete negotiations or face tariffs on ALL products exported to the USA. The US has demanded that China change its laws regarding intellectual property and company ownership and China is refusing saying they will only issue a state council directive instead and would not change laws.

With President Trump continually blasting China for its "illegal" actions it is going to be difficult to produce a deal that is balanced and ensures dignity and dropping the tariffs before there is evidence of deal compliance is not likely to happen.

As of Saturday, I had not heard of any retaliation moves by China, but they are expected. Mnuchin said there are no further talks scheduled.

Saturday morning President Trump warned China to act now on trade or risk facing a worse deal if negotiations continue into his second term. Trump claimed China was hoping to wait for a democrat to be elected to revive the negotiations.

In addition to the tariffs, US warships sailed within 12 miles of China's disputed islands in the South China Sea sparking a complaint from China.

The FCC voted 5 to 0 to deny China Mobil (CHL) a right to operate in the USA. If they had allowed them to operate in the US they would have access to US telephone lines, fiber-optic cables, cellular networks and communications satellites. China has been trying to win approval since 2011. The FCC said allowing China inside our networks would be a security risk. The FCC also warned it was considering revoking licenses for other Chinese carriers that had previously been allowed licenses. The FCC said China Telecom has been hijacking US traffic and redirecting it through China. There is an FCC order pending to require companies to eliminate communications equipment from Huawei and ZTE that is currently in use based on security concerns.

The president is taking the war to China on multiple fronts other than simply trade. This is going to stiffen their resolve not to agree to a strict trade policy. This will also draw out any future negotiations. With a one-month deadline there will be further flare ups and headlines to roil the market.



Friday's economics were market positive, but investors were not paying attention. The Consumer Price Index for April rose +0.3% and less than the 0.4% analysts expected. Energy prices rose but food prices fell for the first time since January 2017. Core inflation, excluding food and energy rose only 0.1%. Energy rose 2.9% for the month. On a year over year basis the index was up 2.0%.

Food prices fell -0.1% but food at home prices declined -0.5%. The CPI for rent increased 0.4%, lodging away from home +1.6% but apparel declined -0.8% after a -1.9% decline in March. Medical care rose 0.9% overall but medical services rose only 0.2%. Household furnishings declined -0.3% and the first decline in a year.

With inflation tame there is no rush for the Fed to hike rates and it would take a significant decline in the CPI for the Fed to cut rates.

We have an active economic calendar for next week, but the only material report is the Philly Fed Manufacturing Survey on Thursday. None of the reports this week should be market movers if the numbers are near the analysts' expectations.


The earnings calendar was cut in half this week but there are still some big names. Cisco, Nvidia and Walmart are the big dogs.

Of the 448 S&P companies that have reported Q1 earnings, 75.4% have beaten expectations. The current earnings forecast of 1.3% growth is significantly better than the -1.8% decline forecast from just a couple weeks ago. 56.9% of companies have beaten on revenue with the Q1 forecast now 5.6% growth.

For Q2 there have been 48 companies with negative guidance with 19 companies issuing positive guidance. Only 9 S&P companies report earnings this week. The Q2 forecast is now for 1.2% growth and 1.8% for Q3. Those numbers are very anemic.


Apple shares had a bad week on worries that China could retaliate against the US by penalizing Apple with tariffs. That could be a double-edged sword since slowing Apple's exports from China would hurt the manufacturing centers in China. Shares fell from the $215 high on the 1st to $192.77 intraday on Friday. That equates to about $75 billion in market cap. Apple is at risk for about $160 in added costs per phone if the full set of tariffs are enacted. Apple could try to absorb that cost or pass it on to consumers.

Apple has a lot of problems and they are trying to convince us they are not a phone company. Unfortunately, 80% of their revenue comes from iPhones and their market share continues to decline. This declining revenue and market share suggest Apple would eat any added tariffs instead of passing those costs in the form of higher prices. That would reduce Apple's earnings by about $3 in 2020.

On the positive side, chip supplier Dialog Semiconductor said China's smartphone market is rapidly recovering. While it was very soft in Q1, it accelerated in late March and April. Q1 shipments overall fell -3% and the lowest level since 2013. Apple's shipments in China declined 30% in Q1 while Huawei saw a 41% surge in smartphone shipments. Xiaomi also showed a surge in sales. Unfortunately for Apple this surge in homegrown brands means further market share loss. Chinese manufacturers are selling $300 phones and Apple is selling $900 phones.

Bespoke Investment's Paul Hickey said it is tough to be bearish on Apple given the decline and the PE of 16 that is 25% less than the technology sector as a whole. If you subtract their cash, planned $75 billion buyback and accelerated dividend, they are a significant bargain today.


Shares of Boeing (BA) fell $30 over the last week on worries of Chinese retaliation and continued headlines about the 737-MAX problems. Victim compensation for the two crashes is expected to be well over $1 billion. Part of that determination will be made by calculating the amount of time passengers knew they were crashing. If they knew they were about to die for 15 minutes the compensation is more than if they only had 3 minutes of warning. The Ethiopian flight crashed 6 minutes after takeoff and the Lion Air crash was 11 minutes into the flight. Those are relatively short periods. It was not as though there was a catastrophic engine failure at 37,000 feet and it took 30 min before the plane glided nose first into a grassy field and exploded. Families in Indonesia have already been approached by Lion Air with 1 billion rupiah offers ($90,000). That is 26 times the annual average income. Forty Lion air cases have been filed in Chicago where Boeing is headquartered. Boeing must settle in advance because a jury trial and award in Chicago could be tens of billions although it would be appealed lower and take years to settle.

If Boeing knew about the potential danger in the autopilot system and failed to warn the airlines, the damages could be significantly more. Boeing has insurance but the deductible would be huge.

Since the 737 accounts for a third of Boeing's profits, there is going to be a challenge over order cancellations and failures to receive new orders because of the stigma over the 737-MAX model. With thousands of 737s in use this is not the same as the Ford Pinto. The model will be rehabilitated once it is flying again. They will probably drop the MAX label and just call it the 737-8 which is the official designation. On May 23rd a global summit of regulators will lay out a path for certifying the proposed software and hardware fixes and arrive at a target date for removing the grounding and letting the planes back into the air. Some airlines are now advertising new routes with the 737-MAX starting in September so clearly, they expect them to be flying again soon. American pilots claim there is no material problem with the equipment, and it was a pilot training error in both cases. In one case an experienced pilot was flying as a passenger in the cockpit and the plane began to exhibit the crash symptoms. He quickly told the crew how to recover and the flight continued. That plane crashed the next day with a co-pilot with only 300 hours of training.

Boeing was also weak on worries over potential Chinese retaliation. Retaliation against Boeing would only cause more wrath from President Trump, so China may not proceed in that direction. The $370 level had been support for several weeks until the China headlines exploded.


3M (MMM) is one company that is actually being hurt by the tariffs on China. However, it is not because of higher import prices in the US. 3M said a sharp decline in automotive and electronics sectors in China caused it to cut production and lay off 2,000 workers. Sales in Asia Pacific which includes China fell -7.4% and Europe, Middle East and Africa (EMEA) fell 9.4%. Not only is the weakness in the Chinese economy impacting all of Asia but the tariffs are having a meaningful impact in China. 3M cut full year estimates from $10.45-$10.90 to $9.25-$9.75. Shares have imploded since the earnings and accelerated last week on the trade disaster. Shares have declined $45 dollars in two weeks and erased more than 300 points from the Dow.


Intel (INTC) single handedly cratered the tech sector last week when they warned to expect only single digit growth in earnings and revenues over the next three years. They said PC chip growth would be flat, but datacenter chips could grow by double digits. Intel once controlled 90% market share in computer processors but they said share had declined to only 28%. Intel suffered several missteps in developing its 10-nanometer technology and will only be able to launch to PC chips late in 2019 and servers in early 2020. Their 7 nm chips are not expected to be out until late 2021. AMD is already producing 10 nm chips and has been for a while and their 7 nm chips will be out later this year. AMD will release multiple models of processors built on 7 nm in Q3. Intel has lost its lead and AMD is surging ahead after being written off as dead for the last decade.

Intel's new CEO Bob Swan warned that the race to catch up to AMD would depress gross margins through 2021 where they should bottom. This is not an encouraging outlook for Intel and the China worries are just one more headwind for the chip giant. The problems of a tech slowdown in China is depressing prices on memory chips leading to a glut of inventory for Intel.


Disney (DIS) reported earnings of $1.84 that easily beat estimates for $1.58 and that was before the $2 billion box office of Avengers Endgame in April. Revenue was $14.92 billion that beat estimates for $14.5 billion. Disney said the record-breaking Avengers Endgame movie would stream exclusively on Disney+ starting on December 11th. Disney reported movie-studio revenue of $2.13 billion, television revenue of $5.52 billion and theme park revenue of $6.17 billion. Earnings will change significantly in Q2 now that they completed the $71 billion acquisition of Fox Corp assets. They sold $10 billion in sports networks to Sinclair Broadcasting to avoid anti-trust concerns. The revamped Disney will be shown in their Q2 earnings. Shares have fallen from their post streaming peak but are holding in the $134 range.


Lyft (LYFT) reported an adjusted loss of $9.02 per share. That is a small improvement from the loss of $11.40 in the year ago quarter, but it is a huge amount of money. Revenue was $776 million compared to the loss of $1.138 billion. They guided for revenue of $800-$810 million for Q2 and $3.275-$3.3 billion for the full year. Active users rose to 20.5 million, up from 14 million. Average revenue per rider rose from $28.27 to $37.86.

The big question now that Lyft is public is how long can it continue to lose $1 billion per quarter with total revenue at $800 million? With Uber and Lyft both losing tons of cash, cheap rides are going to end. If ride prices double to an average of $75 as needed to breakeven, riders will disappear.


The Lyft earnings crashed the Uber IPO. Investors doing the math on Lyft were reluctant to go big on Uber and the IPO was a bust. Uber priced its shares at $45 and closed at $41.55 for a 7.6% decline. It only traded at the IPO price on the opening spike. Thank you Paypal for buying $500 million at $45 at the open. Uber has a much larger business than Lyft but continues to lose more than $1 billion per quarter. Their IPO documents said Uber may never be profitable. That is the biggest problem for both companies. While the ride hailing business has been novel and much appreciated, if they don't make a profit, they will not succeed.

Both Lyft and Uber have been supported over the last several years by venture capitalists with deep pockets. The dream of a big IPO and global domination has fueled their rise but that may end up being a nightmare rather than a dream. Now as public companies they cannot return to those deep pockets for more cash. Reality has arrived and it is ugly.

As public companies they will have to produce profits or at least show a pattern of reduced losses to keep investors engaged. Uber is being sued by its drivers for benefits and higher wages. Uber said driver dissatisfaction is likely to increase as they REDUCE driver incentives to try and reduce losses. Trying to become profitable by reducing $1 billion in costs per quarter is going to be a challenge when driver compensation is their biggest expense. A recent study found that Uber drivers are paid less than 90% of Americans on an hourly basis and they have no benefits like health insurance. EquityZen does not expect Uber to become profitable until 2023 and only then because of Uber Freight and self-driving cars, neither of which currently exist.

Uber's $70 billion in market cap is likely to erode quickly as those venture capitalists see the writing on the wall and see the IPO as an opportunity to exit a bad investment. Uber issued 180 million shares in the IPO. More than 186 million traded on Friday.


Symantec (SYMC) reported earnings of 39 cents that missed estimates for 44 cents. Revenue of $1.19 billion missed estimates for $1.21 billion. CEO Greg Clark abruptly resigned. Board member Richard Hill took over the position on a temporary basis. Clark had been CEO since 2016. The new CEO blamed a miss on the enterprise offerings which produced revenue below the prior guidance. The company guided for full year revenue of $4.75-$4.89 billion and analysts were expecting $4.97 billion. Shares fell 12% on the news.


IBM registered to sell $20 billion in debt to finance its $34 billion acquisition of Red Hat (RHT). US regulators have given their approval for the deal, but overseas regulators are still deciding. IBM expects the deal to close in the second half of 2019. The EU Commission is the current hurdle. Just because the US approved it does not mean the EU will rubber stamp it. Given the bad blood between the US and EU recently they could delay it just to be troublemakers or find some privacy reason to deny it. While it is unusual for the US to clear a transaction and overseas regulators to deny it, this does happen. China denied the Qualcomm acquisition of NXP Semiconductors and cost Qualcomm a $2 billion breakup fee. China did this as a poke in the eye to the US and the trade demands.


Oil prices were dormant for the week at $62 despite increased tensions over Iran and continued declines in Venezuela. Inventories declined slightly but refinery utilization also declined which is highly unusual for this time of year. We should be seeing utilization well over 90%. There have been some unplanned outages and that appears to be impacting the metrics. Refiners should be in full production of summer blend fuels and refined products should be rising steadily.

Active rigs declined by 2, which is minimal and should have no impact on production. It was the decline of -31 a couple weeks ago that was dramatic. As long as oil prices continue to hold at this level there is no reason for a surge in active rigs. The number of drilled but uncompleted wells at 8,500 is the reason active rigs are declining. We will get the April report next week and see if the numbers of uncompleted wells rose.






Markets

It was an ugly week and the rebound on Friday may have just been short covering. The tariff announcement by the president last Sunday night sent the futures on a wild ride lower. That was the start of a major decline in equities but end result was only a 2.2% decline in the S&P and 3.0% decline in the Nasdaq. Had we closed at the Friday lows those numbers would have been nearly 2% higher.

The outlook for the market is negative. While the Friday rebound was blamed on the Mnuchin and Trump comments "negotiations were constructive" anyone with a brain can see there is trouble ahead. The negotiations have stalled with "no further meetings are scheduled" and both countries are firming up their verbal defensives to try and claim the high ground.

Regardless of what China says, they need us more than we need them. They have a billion workers they need to keep working and they require the export income to fund their government spending. Most of the large companies have government ownership positions so a portion of the profits goes to the government. China has implemented 72 stimulus actions to date in 2019. They are working hard to keep the economy moving but they need exports. They can produce all the products they want but much of that goes to the USA.

The resumption of hostilities by President Trump put President Xi in a bad position. As the vice premier said on Friday, the agreement must be structured in such a way to provide each country with dignity. Xi cannot be seen as caving into President Trump's demands. He would lose face in China and that cannot be allowed. This means Xi must stiffen his resolve and maintain a strong front to his people.

Because it is a communist country, Twitter is not allowed. Chinese citizens do not know why their market cratered last week. The news was not allowed to mention trade negotiations. Screenshots of Twitter posts were scrubbed from the internet to prevent them from being received by email or text and forwarded to others. Videos and news items from the US were blocked. Every way the information could come into China was monitored and censured.

That is actually positive for the negotiations since the citizens do not realize there is a big trade fight in progress. Some may know and some may be passing it along, but the vast majority of the 1.3 billion citizens are clueless.

We are likely going to be inundated with trade headlines for the next month and they will increase as China's time runs out. The president will continue ratcheting up his demands and threats and that will roil the market.

We are now in the "sell in May and go away, come back again on Labor Day" period. The first ten days of May have been ugly and with 1% earnings growth in Q1, Q2 and Q3, there is little to entice investors back into the market. They call it the summer doldrums because many investors take the summer off. They do not want to be worried about their positions while they are hiking the mountains, swimming at the beach, on a cruise to the Caribbean or a road trip with the family. Starting the summer off with a 5% decline is a way to push these retail investors back into cash for the summer.

The S&P has traded below the 50-day at 2,861 for two consecutive days but closed back above that level. In theory that support has held. The 2,872 support that held in early April is also back in play. Resistance is back at 2,900 and the new closing high is 2,945 or 64 points above Friday's close. I would be very surprised if we saw that level again next week. We have a better chance for a decline than a rally.


The Dow continues to be hammered by large declines in a handful of stocks. 3M, Boeing, Caterpillar, etc, have erased more than 1,000 points from the Dow in recent weeks. The index is trading back below 26,000 after coming to a dead stop at the 26,616 resistance for two weeks. The lack of Dow components reporting earnings this week could be a plus. Walmart is the only reporter. A lack of multiple reporters means a lack of stocks losing a lot of points. The rest of the index should be calm with the exception of the tariff sensitive stocks.



The Nasdaq was down sharply intraday to 7,759 but rebounded nearly 60 points to close at 7,917 and well over the 50-day average. This was the second day the average was penetrated but the index rebound to close over that level. This is positive and hopefully it holds. The big cap tech stocks were evenly mixed on Friday with the exception of the $94 gain in Booking Holdings, formerly Priceline.com. They missed on earnings but rose anyway.



The Russell 2000 did not lose more than the big cap indexes with only a -2.5% decline. That put us back to the correction level support at 1,566 and the combination of the 50/200 day averages provided additional support. This is somewhat encouraging that small caps did not implode but that is because they are less impacted by events in China. Most are domestically focused companies and immune from a lot of the global trade battle. It also suggests fund managers are not yet ready to pull the plug on the market.


I am worried about the market in the weeks ahead. The indexes were struggling to try and make new highs when it was thought there would be a trade deal at any time. Without that carrot hanging over the market there is nothing to keep traders interested through the summer doldrums. Memorial Day is only two weeks away and that is the kickoff of the summer vacation season. Schools are already closing for the summer and that means more demands on parent's time and attention. There is nothing to prevent the market from posting gains but there is nothing to entice those gains. Earnings at 1% and a full-blown trade war should not produce positive headlines.

Enter passively and exit aggressively!

Jim Brown

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"Never give up, for that is just the place and time that the tide will turn."

Harriet Beecher Stowe


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