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As we go into the second half of the year, there are two questions that are dominating market discussions: 1) Why doesn't anyone want to sell? and 2) Is it time to rotate market leadership?
Let's tackle the first question:
1. Why doesn't anyone want to sell? The markets sure look a little odd. When was the last time you saw almost every asset class up over a six-month period:
Key metrics this year
Kind of odd, no? This should happen all the time. Everyone's a winner! Everyone gets a balloon!
That's the way market participants seem to want it. Everyone wants to have their cake and eat it too. And that contradictory data is a problem that needs to be resolved.
The so-called Goldilocks investment scenario seems to even extend to inflation. ECB Chief Mario Draghi recently said that reflation was coming back, but in the same speech he also said inflation was more muted than expected. No wonder the market was confused.
I think this contradictory data is the main reason everything is up. No one is quite sure what is happening, so everyone has stayed with their convictions: gold being up means more uncertainty, higher bond prices mean the economy is weaker than expected, stocks rising means the global economy improving.
Everyone is entrenched in their camps.
Here's another seeming contradiction: economic data is disappointing at the same time earnings growth is improving. The Citigroup Economic Surprise Index, a gauge of how economic data is coming in compared to expectations, is at its lowest level since 2011.
That's not good news. It means there has been a lot of economic data that has disappointed recently. This week, Goldman Sachs revised down its second-quarter GDP tracking estimate by two-tenths to 2.3 percent following a weaker-than-expected durable goods report.
Bonds, not surprisingly, have been strong in the second quarter.
But there's no disappointment in earnings land: First-quarter earnings are up 15.3 percent, and second-quarter earnings estimates are also up a healthy 7.9 percent, according to Thomson Reuters. Third-quarter estimates are up 8.7 percent, and while the forward estimates usually come down, early second-quarter earnings reports have been solid.
Meal delivery darling Blue Apron is set to price tonight and trade tomorrow at the NYSE. It's getting a lot of interest from the IPO community for one principal reason: Amazon's purchase of Whole Foods has changed the dynamics of home delivery, a business a lot of players want to get into.
This morning, the company cut its expected IPO range to $10-$11, from $15-$17 a share. It is still offering 30 million shares. It's likely Amazon spoiled this party.
Why is home delivery a hot topic for investors? "It's a great way to touch customers directly, particularly high end customers," Kathleen Smith from Renaissance Capital told me. "You can put a lot of items through that channel, not just food. So you can sell wine, almost anything." Indeed: Blue Apron already offers wine.
Here's the good news: There is decent growth. They grew top-line at 42 percent in the last quarter, with a revenue run rate likely to hit $1 billion this year, according to Renaissance. Gross margins of 33 percent are healthy. They have a lot of repeat orders, which account for 92 percent of revenue. It seems reasonably priced: one common metric, price-to-sales multiple, is 2.7 times, according to Smith. Grubhub, Wayfair, Shutterfly and other competitors trade at a roughly 3.0 price-to-sales multiple.
Here's the bad news: large and growing losses, because they are spending a lot on marketing. It's still losing money, $50 million in the first quarter. Customer acquisition costs – the cost of getting each new customer – are rising.
Most ominously, the competition is ramping up. Hello Fresh, which is ready to go public in Germany soon, is already in the U.S. There are others, including Home Chef and Plated, but the big white shark is Amazon.
Amazon Fresh right now is just doing grocery delivery, and while even that has not been a strong suit for them, you can be sure that home delivery is a factor in why they wanted Whole Foods.
And then there's Instacart, which also does same-day grocery deliveries. Here's an interesting twist: one of its biggest investors is Whole Foods, which reportedly invested $36 million in Instacart last year. What does Whole Foods do now, assuming the Amazon-Whole Foods deal goes through? Buy all of Instacart? Incorporate it into Amazon Prime?
Either way, it spells major competition for Blue Apron.
If this is all nothing more than a delivery story, then clearly Blue Apron does not have a very wide moat. But Smith emphasizes that there is more here than just a delivery service. "Blue Apron is not just a delivery company, it's an experience. It's supposed to make people feel good about healthy food that you're making yourself."
Of course, there is not much of a barrier to entry, even for that story.
Rates are jumping right now after global central bankers promised inflation is eventually coming. Bond yields jumped dramatically in Europe and are rising in the U.S. as central bankers have re-emphasized inflation.
But it was this comment that got the bond and currency markets moving: "Now, we can be confident that our policy is working and that those risks have abated. The threat of deflation is gone and reflationary forces are at play."
There's the magic word: reflation. On that, the euro rose to almost its highest level since November of last year. In Germany, 10-year bond yields rose 12 basis points, to 0.37 percent, a 40 percent increase, and French 10-year yields rose 19 percent.
What's odd is Draghi's insistence that the bank's current stimulus program needs to stay in place because inflation still is more muted than expected.
Draghi, of course, is playing the old game of talking both sides of his book, but Peter Tchir, macro strategist for Brean, told me the markets were reacting to that magic word, reflation: "The bond markets are clearly focusing on the 'new news' of Draghi talking reflation rather than the 'old news' that inflation is muted," he told me.
Whether there are longer-term effects to his remarks are not yet clear. However, central bankers seem eager to talk up reflation. Philadelphia Federal Reserve President Patrick Harker today reiterated that the Fed remains on track for another 2017 rate hike, and that recent inflation weakness appears to be temporary. He said, though, that he believes the Fed will not achieve its inflation target of 2 percent until early 2018.
Bond yields are up in the U.S. as well. The U.S. 2-year note hit a high yield of 1.377 percent, the highest level back to March 15.
"People have been long Treasuries right across the board, and I think these comments are triggering some stop losses," Tchir told me. "The idea of staying long bonds as a hedging strategy for stocks is getting a little long in the tooth."
The call is based partly on complacency, partly on the time of year, and partly on what he sees are disturbing trends in other asset classes:
"While global equity trends remain strong and prices near record highs; volatility is at the lows; the put/call hit its lowest level of the year; and crude, the dollar, yields and inflation expectations continue to collapse as we enter a period of thinner trade, heightened volatility and typically weaker equity returns," wrote the analyst.
What's most shocking in his new report is the analysis about the sector Ross believes will lead the downturn.
The analyst notes an eerie similarity between trading on the main Philadelphia Semiconductor Sector index (known as "the SOX") and Bitcoin, and indeed the charts do show a remarkable similarity this year, rising modestly from mid-January to mid-March, and taking off in mid-April.
"I reiterate my sell call on Semi's and continue to see a test of 1,000 on the SOX (-8 percent) as the group continues to display the textbook signs of a reversal in trend and a technical symmetry with Bitcoin, which is down -9% overnight and poised for another -17% to 2,044," Ross wrote.
SOX index (black line) vs. Bitcoin (bar chart)
Source: Evercore ISI
He's not completely negative on the whole market. He has an aggressive call to buy biotech and sell semiconductors against them.
It's summer, and trading is light, but here's something that might perk your interest: Friday is usually the heaviest volume day of the year.
It's the annual Russell Reconstitution, the day when the Russell indexes are rebalanced. There's $8.5 trillion in asset benchmarked to or invested in products based on the Russell U.S. indexes.
Why is this important? Indexes rule the world because passive investing rules the world, and these indexes determine what go into many mutual funds and many ETFs.
The main interest is to look at stocks that are going into or out of the large-cap Russell 1000, and into or out of the small-cap Russell 2000. Both are market-cap weighted indexes. Passive investors tied to these indexes will have to buy or sell these stocks depending on how the stocks have performed in the last year.
The largest 1,000 by market cap go into the Russell 1000. The remaining roughly 2,000 go into the Russell 2000. The breakpoint — the dividing line between the Russell 1000 and the Russell 2000 — is about $3.4 billion.
How the mighty have fallen. This is where it gets a little fun — traders get to see who gets kicked out of the Russell 1000, and who has risen into the Russell 1000 from the Russell 2000.
Let's start with the losers, because, well, there's a morbid sport in looking at once-mighty companies that have seen better days.
No surprise, there's some big retail names that are being given the boot: JC Penney, which is down to a mere $1.4 billion market cap, and Dillard's, which is down to $1.5 billion, are both getting kicked out of the Russell 1000. Some former internet/tech darlings are also getting the boot: Groupon, Yelp and Fitbit.
Finally, it's been a mess for oil companies, and plenty of names are getting tossed: Diamond Offshore, Noble, Ensco, Rown, Penn Virginia.
Steve DeSanctis, SMID-Cap Strategist for Jefferies, notes that the Russell 2000 has traditionally hosted companies on the way up, and then on the way down: "That's one of the problems with the Russell 2000: You do get a heavy dose of companies that are well past their prime, companies that have to reinvent themselves after being a great company."
Then there's the other way around: small companies that are knocking the cover off the ball, and graduating to the Russell 1000.
The best example is AMD, which has had quite a year, going from roughly $5 to $14 in the last 12 months, and adding more shares to boot. "AMD was an also-ran years ago, but reinvented themselves and now they compete with companies like NVIDIA," DeSanctis told me.
So will there be any price action? DeSanctis notes that stocks going from the Russell 1000 to the Russell 2000 often outperform short-term. Why? Because those stocks are going from being a small fish (a small market cap) in a big pond (the Russell 1000) to a bigger fish in a smaller pond (the Russell 2000). They will gain a larger market weight in the Russell 2000, which will force indexers to buy them, often resulting in a bump up in price.
But DeSanctis cautions that this is not an infallible rule. It hasn't happened this year in Energy stocks getting demoted, for an obvious reason: Energy stocks are so out of favor with investors that it is overwhelming any indexer that would buy them. "It doesn't matter what passive guy has to buy these stocks," DeSanctis said. "With oil down so much, these stocks are going to be down even more."
Regardless, one big winner tomorrow will be traders. NYSE volume last year was 6.9 billion shares, more than twice normal volume. That was also the day of Brexit!
Oil took another tumble midday Wednesday, below $43 a barrel, and regardless of the reason we are finally starting to see analysts on the Street throw in the towel and begin to take down 2017 earnings estimates.
The problem is simple: many analysts and strategists are still forecasting average oil prices of $60 this year. It is now abundantly clear that is not going to happen.
So it's about time estimates started coming down. Today a raft of companies dropped ratings on oil companies:
The big issue is, when will supply come in line with demand? More specifically, when will the U.S. shale producers blink? The prices at which companies break even on oil production varies greatly. Guys in the Permian basin can certainly make money at $45. Below that, the air gets more rarefied. Below $40, a lot of these guys are not going to make money.
Will this finally be the event that causes the shale producers to cut production? Maybe, but don't bet on it, at least not yet. One thing that has amazed me about the shale guys: If they have the money, they're going to spend it. They are not particularly good stewards of capital.
Piper Jaffray said they see no signs of a shutdown yet: "Overall, the mood from our E&P contacts was somewhat more reassuring, although not uniform, while our oil service contacts are nervous, though none have experienced any pullback in activity and none have been notified of potential equipment releases."
Stifel notes that we can expect significant reduction in the rig count (currently 747 rigs) once oil gets to $40 and below: at $40 a barrel, they estimate the industry would need to reduce rig counts by 200 to balance cash flows.
Seems like below $40 might be the magic shake-out level.
It's a big move: MSCI controls the indexes behind some of the biggest exchange-traded funds (ETFs) in the world, including the MSCI Emerging Markets ETF. Since the whole world is moving toward ETFs and passive investing, what goes in these indexes is what investors will be owning in the future.
The company is smartly holding out a carrot to the Chinese regulators: Do more to open up your markets, and we will include more of your stocks. That's a big carrot: Chinese authorities desperately want their markets to be more widely owned outside the country.
Here's the key points:
1) MSCI will take 222 of the biggest names in their MSCI China A International Index (out of 448), and include them in their relevant global indexes in the middle of next year. These are the largest and most liquid names in the China mainland market.
2) Rather than giving a 100 percent market capitalization weighting to each stock, they are giving each stock an initial weighting of only 5 percent of its market cap. That will greatly reduce the initial weighting of the China mainland stocks.
Why is that? Because MSCI wants the Chinese authorities to keep opening up their markets. There's three particular things they want to see:
1) Fewer companies halting their stocks;
2) current limits on how much money can enter or leave the country for stock trades on a single day to be removed or greatly expanded; and
3) to make sure that the crucial Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect works effectively. Those two connections are the primary path that enables investors to trade shares listed on each other's markets using local brokers and clearinghouses.
Essentially, they are holding out a carrot to the Chinese regulators. MSCI wants the market to open up more.
"This is a small step in the right direction. For everyone to get experience — so everyone gets to know everyone — we will start small," Henry Fernandez, chairman and CEO of MSCI, told CNBC.
Should the Chinese continue to open up their markets, MSCI will consider increasing the market cap of the existing 222 companies all the way to 100 percent. It will also consider including the remaining 226 or so companies in the future.
It's a measured move that will build confidence in the international community and encourage even more cooperation from the Chinese.
Apparel stocks dive as the Amazon juggernaut rolls on.
First, it was Amazon buying Whole Foods and threatening to disrupt the grocery business.
Never mind Whole Foods has less than 3 percent of that business, the mere fact that Amazon was involved has been enough to send grocery chains into a tailspin.
Tuesday brought Amazon Prime Wardrobe, where the online retailer tackles the biggest problems of buying clothes: 1) the time it takes to shop, 2) the hassle of finding the size that's right for you, and 3) returning stuff you don't want.
Judging by the market's reaction, it looks like the Street believes Amazon has advanced the ball considerably: Nordstrom closed down nearly 4 percent, JC Penney more than 5 percent, and Ascena Group and Chico's more than 4 percent. Even discounters like TJX and Ross Stores fell 3 percent and nearly 5 percent, respectively.
It's a simple idea: try before you buy, and only pay for what you keep. Pick out three items or more, and you get shipping for free (if you're a Prime member of course). You have seven days to try the stuff on and decide what you keep.
UBS says Goldman Sachs will report earnings next year below Wall Street expectations due to its faltering trading business.
Blue Apron's stock jumps after three of its underwriters initiated coverage of the company with strong ratings.
The S&P shows a very strong and stable uptrend with no end-of-trend patterns. Daryl Guppy writes.