Life Is Stranger Than Fiction

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By: Kent Engelke | Capitol Securities

Life is stranger than fiction. Bloomberg recently published an article written by an algorithmic trader. While I did not learn anything new, the author’s comments validated many beliefs. For example, the author stated inputted variables reflect only the perpetuation of the status quo. There is no macroeconomic or geopolitical foresight, security analysis, only the extension of the current.

The author further stated that the predominate “algo” models have created considerable volatility beneath the surface, a point discussed and validated last week by several indices. Volatility on the surface however is virtually nonexistent.

Moreover the author indicated the potential of large imbalances, signaling the outsized influence technology shares have upon such models and the probability of sharp volatility in very under owned sectors such as energy and finance.

In my view, Tuesday evening, an event occurred that may have a profound impact. Media outlets used words such as “stunning,” “unexpected,” “surprising,” “abrupt,” to describe the events. Saudi Arabia elevated the 31 year-old prince to Heir. His rival’s power was reduced to nothing.

The statement the 31 year-old made I think is economically significant. He retroactively reinstated all allowances and bonuses that were cancelled or suspended to civil servants and military personal. In other words the 18-month austerity program was entirely shelved and repaid.

Regarding Iran, the newly crowned leader increased the rhetoric, vowing to “take the battle” to the Shiite-ruled country.

Monday, Bank America wrote the kingdom would face “severe fiscal distress” if oil prices remained at $45/barrel for the next 12 months. This pronouncement was made before the return of yesterday’s status quo of transfer payments.

Yesterday, Iran commented and recommended deeper production cuts are required to boost oil. Currently, OPEC’s compliance to production cuts is 108% and non-OPEC countries are at 100%.

Both of the events are not factored into algorithmic models. Oil yesterday traded off inventory data, which on the surface was bullish, but was later interpreted as negative. For informational purposes, inventories fell for the 10th time in 11 weeks and are now down to the lowest level in four months according to the EIA.

If yesterday’s events occurred five years ago, oil would have surged.

Oil represents the lowest percentage of the S & P 500’s capitalization since 2004… 6% and down from 16% in 2008. Oil the commodity is down about 22% from its February peak, the vast majority of the drop has occurred since May 25, or the date OEPC extended its production cuts.

I rhetorically ask is there an imbalance in the ownership of oil shares, an imbalance that may cause an outsized advance as the result of algorithmic trading if any positive event unfolds, a scenario discussed by the algo trader?

I think the odds of such are over 50%.

Commenting about market action, yesterday was the inverse of two days ago….the NASDAQ advanced about 0.70% while the Dow fell about 0.25%.

Last night the foreign markets were down. London was down 0.36%, Paris was down 0.28% and Frankfurt was down 0.01%. China was down 0.28%, Japan was down 0.14% and Hang Sang was down 0.08%.

The Dow should open quietly lower. The 10-year is unchanged at a 2.16% yield.

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