The Changes Are Indeed Tectonic… How Will The Algorithmic Trading Models Respond?

By: Kent Engelke | Capitol Securities

I think yesterday’s data clearly indicates the economy is accelerating. Jobless claims are at the lowest level since December 1969. Real disposable income posted the greatest gain since April 2015 and hourly wages rose by the greatest amount since 2009. Manufacturing increased the most since May 2004 led by strong growth in exports, the greatest jump in six years. Moreover, inventories fell which suggests pent up growth to replenish inventories.

This data coupled with Powell’s congressional testimony was weighing upon the markets before the President proposed the tariffs on steel and aluminum.

In my view, equities sold off because such is inflationary. The cost of production just rose. I will not venture into the discussion about possible trade wars, but rather focus upon monetary policy implications which in my view are the primary determinate of market direction.

It is now common knowledge the markets are dominated by technology based trading; trading that is based entirely upon momentum. According to Bespoke Investment, the technology sector now comprises about 25.1% of the capitalization of the S & P 500, eclipsing the prior record of 25% in November 2000.

A major difference however between today and yesterday is the massive concentration of wealth in just five companies versus about 50 eighteen years ago. These five companies comprise about 14% of the total capitalization. Wow!

A primary component of algorithmic trading models is interest rates. What happens if the unfolding environment is different than the assumed environment?

The assumed environment is not unfolding. Secular stagnation is replaced by accelerating global growth. Interdependency and multipolarism just received another death blow with the proposed tariffs.

As noted several times, approximately 53% of sales from the S & P 500 came from foreign countries. The comparable portion is about 20% in the Russel 2000 as per Bloomberg.

For what it is worth department, according to Bloomberg, the combined monthly import of steel and aluminum totals about $3 billion. It is the fear of retaliation that changes the inflation calculus, hence valuation models.

What will happen today? The condemnation of the proposed tariffs — nothing radical in a historical perspective as President Bush proposed similar tariffs in 2002 — is rising on all sides. Surprisingly, China’s response is relatively muted even as its economy is an export dominated economy defined as domestic growth is predicated upon shipping inexpensively produced goods to the west. Canada, who is the biggest supplier of foreign steel to the US, is loud.

Last night the foreign markets were down. London was down 0.98%, Paris was down 1.80% and Frankfurt was down 2.21%. China was down 0.59%, Japan was down 2.50% and Hang Sang was down 1.48%.

The Dow should open moderately lower from a combination of trade war rhetoric and the unexpected announcement from Japan that it may “exit” QE. The 10-year is unchanged at 2.82%.

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