Apple "Cooks The Books" As the Market Struggles

Written by Dennis Slothower
Posted May 4, 2018 at 8:00PM

Stocks took a nosedive on Thursday on the opening led by the financial sector, with most of the major indexes breaking below their 200-day moving averages. Stocks rallied late in the day on short covering but were still down for the day.

I think some grew nervous and covered short positions on the chance that trade negotiations with China may be going well and that Friday’s jobs report will be strong. This helped the indexes climb out of the hole and back above the 200-day moving averages.

At least on the jobs report front, they were right. The report came in with 164,000 new jobs and the official unemployment rate fell to 3.9%, a level not seen since 2000.

Tech stocks led a rally that brought the indexes back up to the levels they saw on Wednesday, though they remained on pace to either slightly drop or move sideways for the week.

I think part of the reason why the U.S. stock market is struggling is because of the recent strength in the U.S. dollar, which has recently broken above its 200-day moving average.

It follows that if the U.S. dollar continues to strengthen against a basket of world currencies, U.S. goods become more expensive and that means corporate earnings have likely seen their “peak” in the first quarter.

So the dollar’s rally is suddenly turning into a problem and becoming a headwind. U.S. multinational corporations, which benefited handsomely last year when the dollar was in a bearish trend, are especially affected by a strong dollar.

With the strong U.S. jobs report on Friday, the dollar could keep on rallying.

As you recall, I suggested that when the President’s chief economic adviser, Gary Cohn, resigned, he was jumping ship near the top of the market. He resigned on March 6th. The low in the dollar was the Feb/March period. He was replaced by Larry Kudlow, who has argued for a strong U.S. dollar.

Still, the U.S. dollar is short-term overbought, with the RSI value at 83%, so it wouldn’t surprise me to see a short-term correction in the dollar to help lift the stock market again for a few days.

As I look at individual sectors in the market, three sectors — Consumer Staples (XLP), Real Estate (XLRE), and Utilities (XLU) — are all trading below their 200-day moving averages but also below each of their 50-day moving averages.

For example, notice what is happening to Consumer Staples (XLP).

Furthermore, what is also alarming is Health Care (XLV) is not only well below its 200-day moving average but is getting ready to see a death cross of its 50-day moving average. Not good, as this is one of the largest sectors in the market. The same goes for Materials (XLB), which is in trouble now.

The second big sector is the financial sector (XLF) and it too is just about to breakdown through its 200-day. The Energy sector (XLE) is in a positive uptrend but has a lower high and is looking toppy.

Given the Dow 30 is barely hanging on, it's not surprising to see the Industrials (XLI) also struggling, as it is also below both its 50- and 200-day moving averages.

We now have only two sectors that are trending around their 50-day moving averages: Technology (XLK) and Discretionary (XLY). It could be argued they are still in positive uptrends.

It is a real issue, after a supposedly good earnings quarter, to see the market in this poor of shape.

While we could make an argument for a short-term rally, I think investors will once again be looking to sell into any rally as long as the dollar is advancing, interest rates are rising, the Fed is draining massive liquidity each month, and geopolitical risks seem to be increasing.

Rate Hikes on Schedule

As expected, the Fed decided to leave interest rates unchanged for May on Wednesday, but there is little doubt another rate hike is coming in next month’s FOMC meeting on June 13th, as the Fed is hawkish on inflation and will stick to its plans of three rate hikes in 2018, perhaps even four. This undercut the stock market going into Thursday’s close.

In addition to the March rate hike, look for rate hikes in June, September, and perhaps in December if necessary to invert the yield curve and crush inflation, the Fed's biggest threat. Inflation robs bond investors of returns, driving investors out of bonds and pushing up yields.

In fact, we are starting to see this develop with earnings in companies like Apple.

After Tuesday’s close, Apple computer reported that it earned $2.73 a share on revenue of $61.1 billion, ahead of forecasts of earnings of $2.67 a share on revenue of $60.82 billion.

In order to meet these targets, Apple had to spend the greatest quarterly buybacks of its shares ever at $22.3 billion to shrink its outstanding shares so profits would grow.

To put this into perspective, the amount of stock bought back by Apple is larger than the market capitalization of more than half (275 to be exact) of the 500 companies in the S&P 500 index. Apple is transforming from an innovative and creative company of the past to a generally “financially engineered” company in order to produce significant profits.

It is also burning cash to buy back its shares and pay its dividends. Notice, it did not issue bonds as it has in the past to fund share buybacks and dividends this quarter but used cash instead for the first time.

This is hardly healthy and it isn’t just Apple using “financial engineering” to generate profits for the illusion of growth.

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

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