09/22/17

Welcome To A New Era

By: Kent Engelke | Capitol Securities

I do not think it is a stretch to write that the markets have officially entered into a new era. QE is now replaced with QT. QE lasted about six years and QT is expected to last for five years. How will all markets respond?

Perhaps the only accurate statement to write is that we don’t know. The pontifications will be great, but only history will dictate the outcome. The Fed’s balance sheet is at a record size and such a feat has never been attempted. Mistakes or missteps will happen. It is not a question as to if, but rather as to when.

As noted many times, the vast majority of bulge bracket firms have made bearish pronouncements before Wednesday’s anticipated announcement with Vanguard yesterday reiterating their heightened concern.

A primary component of all valuation models is corporate cash flow discounted by some interest rates. The higher the interest rate, the lower the valuation if everything else remains the same.

It is now widely known there is a great disparity between value and growth. For this discussion, I will define value as energy and the financials and growth as the technologies. Some benchmarks suggest the disparity between the two is as much as 40%, the greatest difference in almost a generation.

Hypothetically speaking, value should outperform in a moderate rising rate environment. Will there be a prolonged period of value out-performance comparable to the prolonged period of growth out-performance, ending only when all declared growth investing is dead just as many have today declared value as dead?

Yesterday, value outperformed closing nominally higher. Growth was down about 0.50%. Is this a harbinger of things to come?

Last night the foreign markets were mixed. London was up 0.17%, Paris was up 0.39% and Frankfurt was up 0.24%. China was down 0.16%, Japan was down 0.25% and Hang Sang was down 0.82%.

The Dow should open nervously lower. The 10-year is up 5/32 to yield 2.25%.

09/21/17

Will The Two Year Treasury Yield 2.75% By December 2018?

By: Kent Engelke | Capitol Securities

The S & P is stuck in one of the tightest trading ranges in history as all attention is now on the endless commentary on reducing the Fed’s balance sheet. Oil is almost at $51 barrel, the highest level in about five months as OPEC is in 116% of compliance of production cuts. Inventories are declining faster than expected as demand is accelerating because of greater than anticipated global growth.

Speaking of the Fed, the Committee’s forecast calls for inflation to remain under 2% for the next 12 months. I ask if oil rises to $55-$60 barrel, will the Fed maintain this forecast? The FOMC intends to increase rates one more time in 2017 and three times in 2018.

If the Committee takes this path, the overnight rate will be yielding more than the yield on today’s 10-year Treasury and close to the current 30-year Treasury yield.

The FOMC also announced its intentions to begin reducing the size of its balance sheet next month in a gradual but consistent manner. What will QT be met?

As noted many times, the consistency from 2010-2015 that was projected for Fed policy did not unfold. In January, I opined about the odds of expected Fed policy again not materializing, defined this time as greater than expected rates because of stronger than anticipated growth.

Yesterday, it was reiterated for the first time since 2007 that all 45 OECD countries — the 45 largest countries in the world — are expecting their economies to expand in 2017, an expansion lasting into 2018. This is a rarity. Such contiguous expansions last occurred in 2007. Before that was in the late 1980s and before that was 1973.

Equities were mixed on the news. Treasuries were essentially unchanged.

Last night the foreign markets were mixed. London was flat, Paris was up 0.51% and Frankfurt was up 0.33%. China was down 0.24%, Japan was up 0.18% and Hang Sang was down 0.16%.

The Dow should open nervously lower as many are questioning the valuations of the market leaders in a potentially higher rate environment and the impact of QT. The 10-year is off 2/32 to yield 2.28%.

09/14/17

The $10 Trillion Resource North Korea Can’t Tap

North Korea may not have proved petroleum reserves, but it’s estimated that the secluded belligerent nation sits on reserves of more than 200 minerals—including rare earth minerals—worth an estimated up to US$10 trillion.

Of course, there are no official reports on how much North Korea’s mineral wealth really is, but according to rough estimates from earlier this decade, Pyongyang’s deposits of coal, iron ore, zinc, copper, graphite, gold, silver, magnesite, molybdenite, and many others, are worth between US$6 trillion and US$10 trillion, as per South Korean projections reported by Quartz.

Before the fall of the USSR, North Korea had prioritized mineral mining and trade with fellow communist partners. But the mining industry has been in decline since the early 1990s, due to decades of neglect and lack of funds for infrastructure development to support mining activities.

Now North Korea’s mining sector trade is under a full ban by the UN, as Pyongyang has stepped up both nuclear missile tests and belligerent rhetoric in recent months. The UN started banning trade in metals last year, but there have been reports that Kim Jong-Un’s regime has grown increasingly inventive in circumventing sanctions.

The UN introduced last month a full ban on coal, iron, and iron ore, after having banned trade in copper, nickel, silver, and zinc in November last year. China also implemented the coal import ban, cutting off an important economic lifeline of the regime. Coal trade has generated over US$1 billion in revenue per year for North Korea, the U.S. Department of Treasury said at the end of August, when it slapped sanctions on Russian and Chinese entities for supporting the regime.

On Monday, following North Korea’s latest nuclear test on September 2, the UN Security Council banned the supply, sale, or transfer of all condensates and natural gas liquids, and banned Pyongyang’s exports of textiles such as fabrics and apparel products. The latest sanctions, however, are not imposing a full oil embargo as the U.S. called for in recent weeks. The sanctions instead are capping refined petroleum products and crude oil supply, after the U.S. dropped its demand for full oil ban, to avoid China vetoing the UN resolution.

All the sanctions leading to Monday’s strongest prohibitions so far have been designed to stifle North Korea’s trade in minerals and cut off money for the regime.

North Korea has staked mostly on coal mining, the cheapest and easiest to mine, compared to precious metals or rare earth metals mining, for which Pyongyang has neither the funds nor the infrastructure or know-how to develop.

North Korea has sizeable deposits of some minerals. Its magnesite reserves are the second largest in the world behind China, and its tungsten deposits are likely the sixth-largest in the world, Lloyd R. Vasey, founder and senior adviser for policy at the Center for Strategic and International Studies (CSIS), wrote in April this year. North Korea sits on sizeable deposits of more than 200 different minerals, and “all have the potential for the development of large-scale mines”, Vasey said.

North Korea doesn’t have either the funds or the infrastructure to develop those resources. It’s also officially banned to export them.

Yet, “The Democratic People’s Republic of Korea is flouting sanctions through trade in prohibited goods, with evasion techniques that are increasing in scale, scope and sophistication,” a UN report of a panel of experts from February this year concluded.

“Diplomats, missions and trade representatives of the Democratic Peoples’ Republic of Korea systematically play key roles in prohibited sales, procurement, finance and logistics. In particular, designated entities are trading in banned minerals, showing the interconnection between trade of different types of prohibited materials,” the panel’s report reads.

According to UN experts—as of February this year—North Korea had adapted to the stricter sanctions “through various tactics, including identity fraud.”

“Their ability to conceal financial activity by using foreign nationals and entities allows them to continue to transact through top global financial centres,” according to the report.

According to a more recent investigation by ABC Four Corners, North Korea has business interests in Asia, the Middle East, and even Europe, contrary to the common perception that it is a very isolated country. Office 39—one of the departments of its Workers’ Party—is “the ultimate slush fund”, reportedly generating up to US$1.6 billion annually for Kim’s lavish lifestyle, while 70 percent of people are food insecure.

“North Korea is very sophisticated in concealing the fact that it is, indeed, North Korea doing business overseas. It’s good at hiding in plain sight,” Andrea Berger, Associate Fellow at the Royal United Services Institute (RUSI), told the program.

Link to original article: http://oilprice.com/Energy/Energy-General/The-10-Trillion-Resource-North-Korea-Cant-Tap.html

By Nick Cunningham of Oilprice.com

09/13/17

10-Year Treasury Yields Almost 10% Higher In Two Trading Days

By: Kent Engelke | Capitol Securities

Equities staged a nominal advance as the Trump administration plotted a strategy for tax overhaul. Financials were the market leaders as Treasury yields rose.

Speaking of Treasury yields, the bench mark 10-year Treasury is now yielding 2.19%. Last Friday, it was at 2.01%, with many then suggesting yields will soon have “1 handle.” Yields are now around a three-week high. As noted many times, approximately 99% of trades in the Treasury market are now done electronically.

A reason for the increase in yields is an unexpected pickup in inflation in England to a four-year high. Chinese and Eurozone inflation is also unexpectedly accelerating.

The PPI is released today at 8:30. Will there be an upside surprise as was the case in many of our trading partner’s economies? If so. what would be the catalyst?

Speaking of a potential catalyst, depending upon the benchmark, oil is around a 4-5 month high. Yesterday, OPEC boosted its 2018 forecast by 400,000 barrels a day, the result of stronger global economic growth. OPEC also trimmed forecasts for growth in oil supplies by 100,000 barrels a day.

The IEA commented yesterday that the world oil market is coming into balance faster than anticipated, a remark that caused Citicorp to challenge the integrity of this once highly esteemed organization. Many times I have commented about the volatility in the IEA’s pronouncements as it appears its outlook changes almost on a daily basis.

What will happen today?

Last night, the foreign markets were mixed. London was down 0.23%, Paris was up 0.01% and Frankfurt was up 0.04%. China was up 0.14%, Japan was up 0.45% and Hang Sang was down 0.28%.

The Dow should open quietly lower even as oil is advancing predicated upon the IEA’s statement that global oil demand will cling this year by the most since 2015, rising by 1.7%, while supplies are contracting about 1%. The 10-year is unchanged at a 2.18% yield.

09/12/17

An Irma/North Korean Inspired Advance

By: Kent Engelke | Capitol Securities

Equities rose and bonds fell after Irma wreaked less damage than expected and North Korea failed to exacerbate tensions. Market direction and volume was dominated by electronic and technology based trading.

As noted the other day, three mega-sized firms have forecasted steep declines in the immediate future given the breakdown of cross-correlated trades, perhaps the result of the massive influence of high speed traders (aka algorithmic) who have programmed trading decisions predicated upon eight word headlines.

This is not investing, but rather short term momentum speculation.

Such strategies create market imbalances and benefit “only a few” according to the SEC.

However, I think the above strategy has created many opportunities for those who utilize a geopolitical and macroeconomic thesis to develop investment ideas. To write the incredibly obvious, depending upon the source/benchmark, this philosophy has greatly underperformed during the last 4-10 years.

I reiterate, if growth is maintained at a 3% pace and if there is tax reform, the odds of security research returning back in vogue rises exponentially for such is the shattering of current assumptions. What are the odds? I think over 60%.

What will happen today? As noted above, yesterday was a light volume advance.

The Dow should open nominally higher on the absence of bad news rather than positive catalysts. President Trump is planning to aggressively promote tax reform, a key ingredient for greater than forecasted growth. The 10-year is off 6/32 to yield 2.16%.

09/6/17

Equities Down And Treasuries Up

By: Kent Engelke | Capitol Securities

Equities trade lower for a myriad of reasons. There was some focus on North Korea, considerable attention on Irma and central bank decisions. And then there is the Trump agenda.

A myriad of firms are forecasting a considerable decline for the averages, a decline if it does occur will be the most predicated decline in history.

Commenting briefly upon Irma, I think the National Weather Service is offering sound advice, defined as it does not yet know where Irma is going, but be prepared just in case. A mid-day bulletin stated it has the same odds of completely missing the US as it does of passing over the Keys. This is a far cry from sensationalist pre-determined headlines.

Treasuries surged yesterday, rallying the most in 10 months. The advance is not predicated upon central bank policy, but is rather technical in nature partially predicated upon North Korea and Irma.

Oil jumped 3.6% yesterday as post Harvey refinery revivals triggered demand boost. I ask cynically why did crude trade lower last week as it was inevitable that demand would return once the refineries reopen?

Last night the foreign markets were down. London was down 0.65%, Paris was down 0.22% and Frankfurt was down 0.07%. China was up 0.3%, Japan was down 0.14% and Hang Sang was down 0.46%.

The Dow should open flat ahead of similar tensions with North Korea, Irma, debt ceiling, etc. The 10-year is off 5/32 to yield 2.08%.

08/30/17

Are The Markets Complacent About North Korea?

By: Kent Engelke | Capitol Securities

Equities rebounded from early morning losses sparked by North Korea firing a missile over Japan. Treasuries retraced some of their gains. To write the obvious, North Korea’s potential outcomes are infinite.

Radically changing topics consumer confidence is at the second highest level since 2000. The labor differential, or the gauge measuring those saying jobs are plentiful minus share saying jobs are hard to get, widened to 18.1 points, the most since July 2001, up from 14.5 the prior month. Share of households who expect incomes to rise in the next month increased to 20.9% in August, up from 20% in July, also a multi-decade high.

Wow! This data is incredible given the incredible vitriol in today’s society.

Today is the first revision of second quarter GDP. Analysts are expecting a slight decline to a 2.6% rate versus the previously reported 2.7% pace, the result of inventory destocking. How will this data influence economic forecasts?

Last night the foreign markets were up. London was up 0.37%, Paris was up 0.49% and Frankfurt was up 0.46%. China was down 0.05%, Japan was up 0.74% and Hang Sang was up 1.19%.

The Dow should open flat as Korean concerns are dissipating. Euro confidence rose to the highest level in a decade. The 10-year is off 3/32 to yield 2.14%.

08/25/17

Another Three Money Center Banks Have Forewarned

By: Kent Engelke | Capitol Securities

Yesterday, a trio of large money center banks warned of an impending bear market. Citi, Morgan Stanley and HSBC all warned of a “big reversal.” The reason for their bearishness is the “breakdown of the 10-year relationship between stocks and other asset classes. This trend of highly aligned and correlated markets has all but disappeared.”

Is this breakdown of the correlated trade the result of everyone using the same strategy… aka chasing returns and momentum? Is it the result of the massive proliferation of ETFs, indexing and algorithms? Is it the result of a tectonic change in geopolitical politics? Or is it the result of potential greater growth that increases inflationary pressures?

Only history will answer this question, but perhaps what I could potentially declaratively write is the cause of this breakdown is probably all of the above and several other reasons few have yet even considered.

Speaking of inflation, the Dallas Fed published a report indicating that inflationary pressures are actually higher than reported and the PCE is closer to target than currently reported. Will FRB Chair Yellen comment about such in today’s Jackson Hole speech?

Speaking of surging, the Bloomberg Weekly Comfort Index reached its highest level in sixteen years. As noted many times, sentiment indicators are the ultimate feedback indicators for they only tell us where we have been, not where we are going. However, given the incredible vitriol and animosity of the last 8 weeks, I think the consistency of these surging sentiment indicators is significant.

I again ask… is the breakdown of the correlated trade that has been in existence for 10 years partially the result of greater than expected growth that shatters current assumptions? All must remember the economy has not grown by a 3% annual rate for over 11 years, the longest stretch in history, far eclipsing the previous record of three years in the early 1930s.

The WSJ reported yesterday that the entire 45 member OECD, comprising the vast majority of the global economy, is growing in sync for the first time in a decade. It has only occurred three times in about fifty years and the last time prior to 2007 was in the late 1980s and for a few years before the 1973 oil crisis. Wow!

Consensus always believes the current trend will last to infinity, defined as the next 10 years, and will be a repeat of the previous 10.

Markets were relatively quiet yesterday, closing nominally lower.

Last night the foreign markets were up. London was up 0.36%, Paris was up 0.24% and Frankfurt was up 0.32%. China was up 1.83%, Japan was up 0.51% and Hang Sang was up 1.20%.

The Dow should open nominally higher ahead of two key speeches today at the Jackson Hole forum, perhaps the two most powerful central bankers in the known universe. The direction however can change significantly if FRB Chair Yellen or ECB Chief Draghi offers insight different than what is expected. The 10-year is unchanged at a 2.20% yield.

08/24/17

JP Morgan’s Warning

By: Kent Engelke | Capitol Securities

JP Morgan again warned the S&P 500 will plunge, the result of “long term low volatility and banded trading.” The bank is concerned about policy shifts, geopolitical tensions and political tensions.

As noted several times, the vast majority of the world’s largest managers — Fidelity, Vanguard, Blackrock, JP Morgan, Merrill Lynch — have all warned of an impending drop.

In some regards, this is bullish for rarely does an expected event occurs. For example, on January 1, all expected the dollar to continue to rally. It is now at levels last experienced in 2015 and may fall back to levels experienced in 2014 when the current rally commenced.

Many industrial commodities have surged in 2017 again defying predictions. And then there is the emerging market rally, a rally few suggested would occur.

Most are now acknowledging a global tectonic change is occurring. These changes occur every generation or about every 25-30 years. In my view, yesterday’s globalism is becoming altered. The altered form is not yet known, but may greatly impact the S&P 100 given their globally interconnected methods of production.

Many times I have remarked about the outsized influence that ETFs, algorithms and indexing have had upon market averages, a view that is now becoming mainstream. This trading strategy is momentum based, defined as the big gets bigger and the small gets smaller, based upon a preconceived set of parameters. What happens if these variables radically change, a change that is inevitable according JP Morgan and others?

I reiterate my long held view the economy will continue to accelerate at a pace much greater than expected that alters the inflationary outlook, threatening current valuations of the largest capitalized names.

In six months, will I be writing about an oil supply shortage that forces prices 50% higher, the result of greater demand and from massive infrastructure cuts? This scenario unfolded 15 years ago and has already unfolded in other parts of today’s commodity markets.

What about housing? Will OER suddenly accelerate? July’s new home sales were disappointing, but the reasons why they were disappointing are inflationary….the lack of supply, available lots and workers that are causing a rise in prices.

There are always winners and losers in change. Companies that benefited from reduced production costs because of outsourcing labor to low cost countries, thrived during the last thirty years. This includes many retailers and technology concerns.

Will tomorrow’s winners be those companies that are focused on domestic production and sales as Main Street America recovers? Only history can answer this question, but I am certain that I will again write life is always stranger than fiction where change is the only constant and the unexpected occurs.

Commenting about yesterday’s market activity, equities fell between 0.40% and 0.30%, while Treasuries gained on the prospects of a government shutdown. Potential tax reform, the catalyst for the prior day’s advance, was perhaps the headline that prevented a larger sell off. Oil advanced on a draw down of inventories, inventories which are now at the lowest level in 19 months.

Last night, the foreign markets were up. London was up 0.51%, Paris was up 0.27% and Frankfurt was up 0.37%. China was down 0.57%, Japan was down 0.42% and Hang Sang was up 0.43%.

The Dow should open quiet ahead of the gathering of central bankers in Jackson Hole. The 10-year is off 5/32 to yield 2.19%.

08/23/17

An Anemic Narrow Rally Pushed The S&P 500 Back Over Its 100-Day Moving Average

By: Kent Engelke | Capitol Securities

Stocks led by the household technology names rose above its 100 day moving average on very anemic volume, the result of decreased political tensions and building momentum to reform the tax code. As noted many times, tax reform is essential to ensuring greater economic growth.

In my view, four major components are already in place for greater potential growth — rising home prices, record job openings for qualified workers, rising monetary velocity and regulation freeze/reduction. However, tax reform in my view is the biggest variable.

The tax payer, not the government, is the best steward of one’s monies.

Commenting further about the lack of breadth in the markets, hedge fund after hedge fund, active money manager after active money manager, are discussing the danger of today’s imbalanced market, the result of ETFs and indexing. Ten years ago, the total capitalization of ETFs was about $400 billion. Today it is over $3 trillion.

Bloomberg writes there is a historic low macro and micro correlation, defined as how closely stocks move versus each other. It is around 18%, which is the lowest reading since 2004. One year ago, it was 60%.

It is widely known that 40% of 2017 S&P 500 return is focused in a sector that comprises around 20% of it capitalization, more specifically the return of five companies.

Many of the bulge bracket firms — firms that pioneered ETFs and indexing including Blackrock, Fidelity, Vanguard, JP Morgan, Merrill Lynch — are all predicting a decline in the averages, primarily the result of narrow based markets, the concentration of funds in passive investments, the structure of which is not known, declining earnings and rising interest rates.

If the markets do decline, this would be the most predicted decline in history.

I reiterate my view that there is a transition from Wall Street to Main Street, monies gravitating into the real economy. During this transition, the averages may decline 7% to 10%, but the typical company advances. In other words, the complete inverse of the last 4 years.

It is often written it is darkest before its brightest dawn. For those who still ascribe to fundamental security and macro-economic analysis, the moment is very dark.

Is tax reform the elixir for the return of yesterday where sector analysis was pivotal for security selection?

I think yes, but only history can answer this question.

What will happen today.

Last night the foreign markets were up. London was up 0.03%, Paris was up 0.07% and Frankfurt was down 0.01%. China was down 0.08%, Japan was up 0.26% and Hang Sang was up 0.91%.

The Dow should open moderately lower on Trump’s threats to end NAFTA, a point that he made during the campaign. European manufacturing data suggested the region’s growth will be stronger than expected. The 10-year is unchanged at a 2.21% yield.