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Stocks plunge may have been a too fearful reaction to trade, economic worries

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After sharp gains in the past week amid hopes for a trade deal, stocks fell back into correction mode Tuesday, plunging on worries the trade talks could fail and that global growth is slowing.

But some strategists said the selling, which took the Dow down as much as 800 points intraday, appeared to be overdone and could have also been made heavier by the fact that the stock market is closed for a full day Wednesday for President George H.W. Bush’s funeral. The selloff was also exacerbated by a big move in the bond market, with the trading there flashing warning signs about the economy.

“I don’t think this continues. I think this is people with their hair on fire,” said Steve Massocca, managing director with Wedbush Securities. “You had this rally that was based on this presumption that we had a deal with China. Now it’s clear, we don’t’ have a deal with China. We might have progress, but we don’t have a deal with China.”

The S&P 500 lost 3.3 percent, falling to the psychological 2,700 level, while the Dow Jones Industrial Average was off 3 percent at 25,027. The Nasdaq was down 3.8 percent, falling back into correction territory, and the small cap Russell 2000 lost 4.4 percent, its worst day in seven years.

Selling in the S&P accelerated around midday. when it broke its 200-day moving average at 2,762. Apple, which has been a beacon of market sentiment, was battered, losing 4.4 percent amid more concerns about iPhone sales. Tech was broadly lower, losing 3.9 percent, while the best performing sector, utilities, was barely positive. Regional banks were down 5.6 percent in the worst day since June, 2016, as interest rates sank.

Scott Redler, partner with T3Live.com, said there could have been some selling ahead of Wednesday when the market will be closed since traders won’t have the ability to control their positions. “For me cash is a position. We’ll have to go into Thursday and Friday and see if today had a lot of meaning or not,” he said.

President Donald Trump met with China President Xi Jinping Saturday, and the U.S. said it left the meeting with a standstill on new tariffs and an agreement on agriculture with China. But, reports have surfaced that China has a different version of events without the commitment on farm goods.

The worries about trade have been eating at investors, who have already been concerned that earnings will slow down next year, and so will stock market gains.

So it didn’t help that the bond market was sending its own scary signals about slowing growth. One of the biggest catalysts for the selling Tuesday was the behavior of the yield curve, which shows the relationship between short and longer-term government bond yields. Buyers jumped into the 10-year Treasury note, pushing its yield sharply lower and closer to the 2-year note yield.

Since some short term yields have risen above the 5-year Treasury already, traders speculated that the same could soon happen between the 2-year notes and 10-year notes. That is what the market calls inversion and has been a recession signal for decades. The difference between the 2-year and 10-year yields was at a narrow 11 basis points in afternoon trading.

Paul Hickey, co-founder of Bespoke studied the behavior of stocks and the yield curve, and said he found the stock market did a little better on average over the course of the next three, six and 12 months, when the spread between the 10-year and 3-month bill fell below 50 basis. He said there were eight occurrences since 1962 when the spread fell below 50, and only six of them preceded a recession.

But the narrower, or flatter, the curve gets, “the worse it is for the market,” he said. “Even worse for the market is when it’s below 50 and already inverted.” That spread fell below 50 for the first time in 11 years, and it is the part of the curve the Fed sees as most representative of fed funds.

“When you get the worse performance is after it inverts and gets positive again, and that’s when you really see the market weaken,” Hickey said.

Vinay Pande, head of trading strategies at UBS Global Wealth Management’s Chief Investment Office, said recessions often do follow inversions but there is no consistent pattern. “It’s between 50 to 600 days to an equity market top, going back to the 1980s. This is not a very useful thing,” he said.

Traders have been pointing to the speed at which the 10-year fell from above 3 percent to the 2.87 percent it was on Tuesday. Pande said part of the reason was that there was a large short position, and investors were forced to cover shorts, as well as some weak data points and inflation reports.

“We actually like the equity market here. I think the market has priced in a reasonably bad outcome,” said Pande. Barring a failure of China and the U.S. to find a trade agreement, he said the market should be alright.
“Near term we think you should be buying the dips,” he said.

Ari Wald, technical analyst at Oppenheimer, said Tuesday’s selling was more of the same pullback that roiled the market in October and November, after its reprieve.

“The market is oscillating in that type of range bound manner. I think it’s all suggestive of the same action we’ve really seen in recent months. This bottoming formation that’s trying to take place. The S&P is still below key resistance at 2,815 sot he bottoming continues,” he said.

Redler said the bottom of the range is 2,603 which the S&P hit in October. “The market is in a range. It’s trying to figure out what the bigger picture looks like, while traders navigate the technical points. A contributing factor was that traders got caught in Apple” Monday when it traded higher. “It looked like it had relative strength, but then the Cirrus news came out and it got downgraded. It’s another worm in the Apple.”

Cirrus cut its guidance due to weakness in the smart phone market.



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Booming rally in small-cap stocks reaches historic proportions

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Traders and financial professionals work ahead of the opening bell on the floor of the New York Stock Exchange (NYSE), January 14, 2019 in New York City.

Drew Angerer | Getty Images

Traders and financial professionals work ahead of the opening bell on the floor of the New York Stock Exchange (NYSE), January 14, 2019 in New York City.

Small caps’ snapback is flashing an ominous signal.

The Russell 2000 has rallied 16.5 percent in 2019, the third best start to a year since the index’s inception. However, small caps’ future is bound to be bleaker if history is any guide. According to Jefferies, in the previous five best starts to a year, small caps suffered weaker-than-average performance in the following three months and squeezed out only a 1.2 percent gain for the rest of the year.

“Can’t draw up a better start to new year than this, however we need a pullback,” Steven DeSanctis, a Jefferies strategist, said in a note on Sunday. “We’d like the market to take a breather.”

He added that earnings have shown strong double-digit growth, but small caps still trail large company earnings, and the outlook for first and second quarter is “in the red.”

Small-cap stocks dipped into bear market territory when recession fears triggered a massive sell-off in December. Now, the group is up 24 percent since Christmas Eve, but the strong comeback might be overlooking the poor earnings outlook. Wall Street is now foreseeing a 2.9 percent decline in small-cap earnings in the first quarter, according to FactSet. In addition, the China trade uncertainty is clouding the road ahead.

“If the U.S. does not get a trade deal done with China over the next few weeks, a recovery in earnings growth is unlikely, as companies put off capex until 2020,” DeSanctis said. “This is one of the biggest risks for the market and explains why we have not raised our Russell 2000 year-end target of 1550.” The index is currently trading at around 1,569.

Growth stocks are seen beating value stocks in the small-cap world given the earnings growth, DeSanctis pointed out.

“The next two quarters should be weak and even down year-over-year for Small and Large caps. We think this supports our Growth over Value theme. [Growth stocks] do look better with the price to book and price to sales ratios double digits below average,” he said.

The strong rally coupled with downward earnings revisions have also made small caps expensive again in a short period of time. The Russell 2000 is trading at 19.8 times forward earnings.



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Papa John’s to struggle despite activist, analyst downgrades to sell

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A customer enters a Papa John's restaurant in Louisville, Ky.

Luke Sharrett | Bloomberg | Getty Images

A customer enters a Papa John’s restaurant in Louisville, Ky.

Papa John’s investors will be disappointed in the near term as sales struggle, according to one Wall Street analyst.

Stifel’s Chris O’Cull downgraded the stock to sell from hold on Monday and wrote that the company’s recent promotions suggest the embattled pizza maker is struggling to compete for customers in the face of low-price deals at rivals Dominos, Pizza Hut and Little Caesars’. But for the restaurant chain to bolster sales, the analyst believes it will need to commit to subsidizing franchisees, a direct threat to earnings over the next few years.

“In order for Papa John’s to drive transactions we believe it will need to commit to an everyday low price menu that will probably hurt franchisees’ profits until consumer perception of its value changes,” O’Cull wrote in his note. “These offers are clearly designed to drive transactions, but to be successful they must increase transactions enough to offset the dollar impact of the discount, otherwise the results lower store margin percentage and dollars.”

Stifel reduced its 2019 earnings per share estimate to 80 cents from $1.20 (well below the Wall Street consensus estimate of $1.19) and cut its price target to $35. The new price target represents 22 percent downside from Friday’s close of $45.26.

The downgrade comes about two weeks after the company announced a $200 million investment by activist hedge fund Starboard Value. Papa John’s said Starboard CEO Jeffrey Smith will become its chairman following the fund’s investment in the form of a convertible stock purchase of 11 to 15 percent.

Activist investors typically accumulate stakes in companies they believe are undervalued and encourage executives to adopt changes they think will boost returns for shareholders. Such demands can range from board seats and CEO replacement to an entire sale of the business.

Papa John’s stock was unchanged in premarket trading Tuesday morning.



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UAE announces IDEX weapons deals as Middle East arms spending climbs

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Attendees walk the floor at IDEX, the International Defence Exhibition and Conference, in Abu Dhabi in 2015.

Markus Matzel | ullstein bild | Getty Images

Attendees walk the floor at IDEX, the International Defence Exhibition and Conference, in Abu Dhabi in 2015.

The United Arab Emirates announced about $1.35 billion in defense deals with local and international companies on the opening day of IDEX 2019, the International Defence Exhibition and Conference, in Abu Dhabi on Sunday.

Of the 33 deals announced Sunday, 18 were domestic and 15 were with foreign firms, the latter accounting for just under $1.1 billion of the total, an IDEX spokesperson said during a news conference.

American companies took the greatest share of foreign sales, at about $490 million. Led by Raytheon, Lockheed Martin and Hesco, the deals will provide missiles, new radar systems capabilities and defensive shelters for the UAE military, respectively. Others notching sales to the country included France’s Thales, Australian firm EOS Defense and Germany’s Rheinmetall Electronics.

The deals with 18 domestic firms highlight the small Gulf country’s investment in developing its own defense manufacturing industry as part of a drive to diversify its economy away from oil.



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