11/13/18

Will The Markets Retest Their Late October Lows?

By: Kent Engelke | Capitol Securities

Led by tech, equities declined. There are numerous uncertainties… the Fed, tariffs, earnings, inflation, political issues including impeachment and other threats, Brexit, etc.

Oil, however, initially rose as Saudi Arabia unilaterally reduced oil exports by 500,000/day in December, calling for other producers to do the same, cutting production 1 million barrels from October’s levels. Gains became losses following the President’s tweet stating: “Hopefully, Saudi Arabia and OPEC will not be cutting oil production.”

As widely discussed, five weeks ago oil was $75 barrel with many firms suggesting/forecasting $100 oil in quick order, partially the result of Iranian sanctions. Last week, crude was down over 20% from those levels because of increased production/shipments. Will prices now rebound by the same magnitude in quick order?

Increased volatility is typically associated with a market top or bottom, a volatility that is today amplified by the massive proliferation of technology-based trading.

Speaking of which, most major equity averages have now retraced over 50% of the post-election surge. Will the late October lows be tested? Will the retail investors who have supported FAANG now become sellers instead of buyers?

Historically, the markets are entering into a seasonal period of strength. The question at hand is what will be the catalyst for a sustained market advance? As noted above, coverage of the multitude of uncertainties is rising.

Consensus believes political gridlock is good for the averages as the odds of any significant legislation being passed are low. I recognize this view but will also write there are considerable issues that the government must tackle but there are always considerable issues to overcome.

Ultimately it is earnings and interest rates that dictate equity direction. Government’s role is to create policies that are conducive to economic and job creation.

Returning back to a previous question, will the averages retest their lows? Bank of America said ‘yes’ based upon several technical indicators. As all know, the markets have been hijacked by technology-based trading where speed and cost of execution are valued more than liquidity and capitalization. The vast majority of these strategies have failed, producing losses anywhere between 10% and 45%.

Are the markets on the edge of yet another iteration, an iteration back to fundamental analysis where geopolitical and macroeconomic considerations are again paramount? If 89% of dollar-denominated assets have produced a negative return as per Deutsche Bank based on current strategies, the answer is yes.

Last night the foreign markets were up. London was up 0.12%, Paris was up 0.38% and Frankfurt was up 0.78%. China was up 0.93%, Japan was down 2.06% and Hang Sang was up 0.62%.

The Dow should open moderately higher on trade hopes. Oil is down for a record twelfth consecutive day following Trump’s tweet criticizing Saudi Arabia’s plan to cut output. The 10-year is up 4/32 to yield 3.17%.

11/7/18

The Midterms Are Over… What’s Next?

By: Kent Engelke | Capitol Securities

The midterms are over. There is an infinite number of opinions about the possible outcomes out there. Economics prevailed in the Senate as the Republicans increased their number of seats but lost in the House as power shifted for the first time in eight years.

In some regards, the outcome is as suggested, in other regards they are not. Personally, I thought the status quo would remain, the result of the strong precedent of voters voting their pocketbooks. In some regards, this view was correct and in other regards it was wrong. It was no “Blue Wave” but similarly the status quo was not maintained.

The immediate focus will now be the commencement of the two-day FOMC meeting and the upcoming G-20 meeting. Even though no action is expected regarding monetary policy, all Fed meetings are potentially significant. As stated, will the Fed begin telegraphing their intent to end forward-looking guidance sometime in 2019?

Regarding the G-20 meeting, at this juncture little is expected regarding trade issues between the US and China.

Equities are expected to open moderately higher as the election uncertainty is over and under the traditional belief a split Congress is bullish for equities.

The 10-year is up 8/32 to yield 3.20%.

Last night the foreign markets were mixed. London was up 1.15%, Paris was up 1.31% and Frankfurt was up 0.99%. China was down 0.68%, Japan was down 0.28% and Hang Sang was up 0.10%.

10/31/18

Will $1 Trillion Be Known As The Top For A Generation?

By: Kent Engelke | Capitol Securities

October left all bruised. Today’s rules that are based on investing models were supposed to take the guesswork out of buying and selling decisions, utilizing technology and using math to eliminate emotions. I think most will agree that such programs are now being questioned. Will October be regarded as the month that all of yesterday’s no-lose strategies failed?

Speaking of possible tops, will $1 trillion end up being known as the Top for a Generation? Two companies “Amazon and Apple” reached this plateau and the media was filled with the countdown for the next companies to make it to this stratospheric level. At the time of this writing, Amazon is down about 23% month to date and over $275 billion from its September apex. Apple is still worth $1.02 trillion but is down about 7% for the month and 9% from its peak.

Yesterday equities had a tumultuous day, ending higher after a robust buying that occurred in the final 30 minutes of trading. At the close, Facebook posted results that perhaps proved to be “good enough.” I am certain the interpretation of the results will change several times throughout the day.

At the close today, Apple posts results. How will they be interpreted?

Last night the foreign markets were up. London was up 1.46%, Paris was up 2.11% and Frankfurt was up 1.26%. China was 1.35%, Japan was up 2.16% and Hang Sang was up 1.60%.

The Dow should open moderately higher on earnings and robust foreign markets. The 10-year is off 5/32 to yield 3.15%.

10/25/18

What Are We To Think Of These Warnings?

By: Kent Engelke | Capitol Securities

The NASDAQ plunged 4.4% for its biggest single-day drop since August 2011 and now is officially in “correction territory” falling 12% from its August peak. APPL, AMZN, MSFT, and GOOG comprise about 25% of the index’s value and were responsible for the majority of yesterday’s decline.

The S&P 500 and the Dow had declines of 3.09% and 2.41% respectively and are negative for the year. October is the worst month for the S&P 500 since February 2009.

The pivotal 200-day moving average on the S&P 500 fell for the first time in 2½ years. The S&P 500 has declined 13 of the last 15 days, something that has not happened since March 2009.

Many times I have commented about the outsized impact of algorithmic or technology-based trading has upon the markets. In rising markets, little regulatory attention is focused upon this domination.

Yesterday I read SEC comments about the recent increased volatility, the product of many things including the normalization of interest rates and other geopolitical events which are fluid. Typically these are things traders are meant to deal with and provide stabilization when needed.

However, today, a discussion is rising about the neutering of market making capabilities which have robbed the markets of predictable and constant liquidity. The SEC states that “it is such a potentially systemic and intractable problem” that it is largely left to academics to dismiss and the regulator hoping everything will work out.

To me, this is a powerful admission, an obvious admission to anyone who has worked on a fixed income (and equity) trading desk. It is my firsthand experience liquidity is lacking in the fixed income markets, a lack of liquidity that the academics [and perhaps regulators] believe is still present.

Historically, money center banks provide liquidity but because of regulatory fiat, money center fixed income bond inventories are down over 90% from levels of 10 years ago while the bond market has swelled three times in size.

Yesterday, I referenced former Fed Chairman Greenspan’s remarks that unfortunately ”a system” needs to come apart at the seams before any action occurs and most often “one does not see these crises arising until it is at your doorstep.”

Continuing with this theme, JP Morgan warned yesterday of the inherent dangers of index (passive) investing. The bank states there is $7.4 trillion of assets managed by passive funds around the world concentrated primarily in large-cap stocks that will exacerbate a rout.

JP Morgan states that passive investing seems to be trend following, with inflows pushing equities higher during bull markets and outflows likely to magnify their fall during corrections.

Back in 2007, the strategy’s overall size amounted to about 26% of all managed funds with about 15% outside of the US. Eleven years later those figures have jumped to 83% and 53% respectively.

JP Morgan states passive investing is “far more skewed to large caps than what their market cap would command… passive AUM in large caps is 10 times that of small and mid-caps making this asset class far more exposed to momentum selling during market downturns.”

Wow! In my view, the comments from both the SEC and JP Morgan are significant and should be reflected upon.

The next question at hand is whether the individual security outperforms the indices in this rotation of monies back to Main Street from Wall Street. In other words, will the typical no-name stock that is not owned by the ETFs (90% of listed securities comprise less than 10% ETF ownership according to SocGen) outperform, the inverse of the last 10 years?

If one uses history as a guide, the answer is yes.

What will happen today?

Last night the foreign markets were mixed. London was up 0.18%, Paris was up 1.45% and Frankfurt was up 0.48%. China was up 0.02%, Japan was down 3.72% and Hang Sang was down 1.01%.

The Dow should open significantly higher. Equities are vastly oversold, several high profile companies surprised on the upside and there are no major changes in the geopolitical environment. The 10-year is off 8/32 to yield 3.14%.

10/23/18

The Next Two Weeks Can Be Pivotal

By: Kent Engelke | Capitol Securities

The next two weeks can be crucial in determining the direction of the markets. Earning season accelerates today with some high profile announcements. Later in the week the likes of Amazon, Google, and Microsoft report.

All will be focused not only on the results but also management commentary especially surrounding the important task of quantifying tariff risk.

To date, about 15% of the S&P 500 has released results. Approximately 85% of results have exceeded expectations but top-line results are disappointing as only 65% have beaten estimates versus last quarter’s pace of 72%.

And then there is the election. What can be written that has not yet been discussed? I have my views but like most, they are rhetorical and conjectural. I will, however, write historically the pocketbook dictates electoral outcomes.

Many times I have used the word tectonic to describe today’s environment. Monetary policy has changed to “quantitative tightening” from “quantitative easing.” Globally the geopolitical landscape has changed to economic nationalism from interdependency and multipolarity.

Earnings momentum has also changed where the percentage increase for value EPS will exceed that of growth EPS for the first time in at least 10 years.

What has not changed is the market strategy where passive investing is still dominating, a total domination from the largest capitalized technology names, companies that are now beginning to face the wrath of global governments.

Will these companies disappoint? And if so, will there be a tectonic rotation from passive to active management? As widely discussed, passive management has greatly outperformed active management for many years, partially the result of the unending flow of monies into ETFs and index type products, a strategy that benefits the largest capitalized concerns.

Change is the only certainty and in my view, the odds are rising that historians will view the last two years as tectonic, a gateway into another era.

Commenting briefly on yesterday’s market activity, the 10-year was flat, the NASDAQ was up by 0.25% and the S&P 500 was down 0.40%.

Last night the foreign markets were lower. London was down 0.50%, Paris was down 0.97% and Frankfurt was down 1.50%. China was down 2.26%, Japan was down 2.67% and Hang Sang was down 3.08%.

The Dow should open sharply lower on various geopolitical concerns. Will earnings help stem the bleeding or has the psychology changed to sell on any strength fearing that peak results are behind some companies? The 10-year is up 12/32 to yield 3.16%.

10/17/18

S&P 500 Back Over Its 200-Day Moving Average

By: Kent Engelke | Capitol Securities

Equities rose as earnings provided a respite from tension over trade and geopolitics. The S&P 500 rallied back above its 200-day moving average as early profit reports suggest that neither tariffs or tightening conditions are as bad as some have been suggesting.

Buying accelerated late in the day… buying that was the result of technology-based trading.

Is intense volatility the new trend?

Speaking of trends, Blackrock, the world’s largest money manager, saw its net inflows soften in the third quarter to the lowest since 2016. Blackrock stated institutions withdrew $24.8 billion from its index and active products. These outflows, however, were offset by its iShares exchange-traded business.

What I found interesting is its earnings statement: “Institutions do not understand the political instabilities…they are worried about the impact of global trade. A common conversation we are hearing from clients is: are we at peak earnings?”

As noted, institutions are withdrawing monies while their iShares (indexing) is gaining money. Historically, when retail monies dominate a trade, the trade is in its final inning. How will this scenario unfold especially as indexing is perhaps the most crowded trade ever in mankind?

NFLX reported earnings at yesterday’s close. It was the inverse of the second quarter’s report. Shares are substantially higher.

Last night the foreign markets were mixed. London was up 0.19%, Paris was down 0.21% and Frankfurt was down 0.49%. China was up 0.60%, Japan was up 1.29% and Hang Sang was up 0.07%.

The Dow should open moderately lower even as some high profile companies surprised. What caused a reversal of the sentiment? Equities going too far too quickly? Bloomberg writes: “There is a colossal change in sentiment from yesterday’s close to today’s opening.” How will this day unfold? The 10-year is unchanged at 3.16%.

10/11/18

Will The Sell-Off Accelerate?

By: Kent Engelke | Capitol Securities

Will the selloff accelerate? A reason for the equity decline is the rise in interest rates. As noted many times, capitalization and liquidity have been sacrificed for speed and cost of execution. Such a scenario is creating a liquidity crisis.

Until yesterday, the two-day selloff of bonds from ETFs was generally orderly. However, with this written, major fissures are now appearing as many platforms have withdrawn from the markets creating a possible vacuum. If there are no buyers, what or who will support prices?

As noted a gazillion times bond trading mechanics have changed exponentially where money center bank bond inventories are down over 90% from 2008 levels. Total debt is up over 200%.

I can write with some certainty the selloff in equities is also the result of the lack of liquidity. There are emerging stories of market stabilizing mechanisms withdrawing from the equity markets in a similar manner as to what occurred in the early February swoon.

Bloomberg writes that yesterday was the eighth time this year the S & P 500 fell more than 2%, the greatest number since 2011. Last year there were zero 2% down days. Bloomberg further writes since 1980 the frequency of 2% declines in a non-recession year was less than 6 days. The S&P 500 declined 3.3%.

The NASDAQ 100, or the largest companies that comprise the NASDAQ, fell 4.4% yesterday, its worst drop since 2011. The NASDAQ Composite was off 4.1%, the biggest loss since 2016.

Will earnings rescue equities? As noted many times, EPS growth is greater for the “value” firms as compared to “growth.” The issue at hand is everyone owns growth creating the largest disparity between growth and value in history, a disparity amplified by the massive proliferation of ETFs.

Circling back around to the Treasury markets, Treasuries closed nominally unchanged but I can write with absolute certainty the typical municipal or corporate bond was down, the result of continued ETF selling. Treasuries were supported by a possible “flight to quality bid.”

What will happen today? Earnings season commences tomorrow with the release of three money center banks’ third-quarter results.

Last night the foreign markets were down. London was down 1.62%, Paris was down 1.56% and Frankfurt was down 1.10%. China was down 6.54%, Japan was down 3.89% and Hang Sang was down 3.52%>

The Dow should open sharply lower following a selloff in the foreign markets. The selloff is being blamed on a number of events. I think the three most significant are rising interest rates, a massive concentration of wealth in a few sectors and the extreme popularity of the index trade, and the potential implications of a massive intrusion/hacking into the technology supply chain.

The 10-year is off 3/32 to yield 3.18%.

10/2/18

Life Is Stranger Than Fiction… Will The 2018 Midterms Be Viewed In A Similar Manner As The 1954 Midterms?

By: Kent Engelke | Capitol Securities

Wow! Life is indeed stranger than fiction. The Kavanaugh hearings. Rosenstein. The new NAFTA. Oil. Interest rates.GE. And this is just a few of the events of the past four days.

Volumes have been already written about the above. One’s innate bias can easily be validated.

Commenting about GE, eighteen years ago, GE was viewed as a company that could do no wrong. It was the largest company in the world. Its management was viewed as omnipotent and every organization attempted to emulate it. It was the most widely followed and was the most recommended stock in history. Its AAA rating was sacrosanct.

Today, it is a shadow of itself, down about 82% from its apex, viewed by many firms as a “speculative buy.” Wow!

What will be written in 10 years about today’s market leaders? The greatest difference between now and then is that today’s market leaders dominate the indices and investing strategies. Their capitalization is unfathomable. Because the prices of their shares are in the mid-triple to four digits, any volatility will have an outside impact on the indices

Will AAPL be viewed in a similar manner as Lucent? Will Google be regarded as Prodigy? Will Amazon be thought upon as another Montgomery Ward or Sears?

Friday the all-inclusive September employment report will be released. Twelve months ago, consensus expected the economy would slow and unemployment would rise. The economy today is growing at the greatest pace in 10 years. The labor participation rate is rising which should support wage increases.

Last spring I was writing the upcoming midterms are the most significant midterms in at least two generations. Most are now supportive of this view. Historically, the electorate votes their pocketbook. Against this backdrop, the Republicans should increase their seats in Congress.

Also historically, the party of the incumbent loses an average of 30 House seats and 3 Senate seats. Perhaps the safest comment to make is this president is the most controversial president in many generations, where the establishment is defined as anyone in the political/media/business elite and who also harbors great vitriol and animosity towards him.

What are the odds the Democrats have overplayed their hand similar to the McCarthy era, the last era of character assassination where one was guilty before being proven innocent and the fundamental right of Due Process was ignored?

For those that do not recall, Senator McCarthy was a Republican who was blamed for the Republican loss of the House in 1954. The Republicans did not again capture the House until 1994.

In my view, the greatest risk of the current political fiasco is the gross violation of Due Process, the fundamental right that differentiates the US from the vast majority of other countries. As noted, this violation was a major reason for the Republican’s stunning 1954 loss.

What will happen today?

Last night the foreign markets were mixed. London was down 0.42%, Paris was down 0.71% and Frankfurt was down 0.76%. China was up 0.83%, Japan was up 0.10% and Hang Sang was down 2.38%.

The Dow should open moderately lower on Italian statements that it would have solved its fiscal problems with their own currency, albeit the indebted nation did state it had no intentions of leaving the Euro. The 10-year is up 5/32 to yield 3.07%.

09/26/18

$100 Oil Is A Distinct Possibility

By: Nick Cunningham | Oilprice.com

An oil price spike is starting to look increasingly possible, with a rerun of 2008 not entirely out of the question, according to a new report.

The outages from Iran are worse than most analysts expected, and bottlenecks in the U.S. shale patch could prevent non-OPEC supply from plugging the gap. To top it off, new regulations from the International Maritime Organization set to take effect in 2020 could significantly tighten supplies.

Put it all together, and “the likelihood of an oil spike and crash scenario akin to the one observed in 2008 has increased,” Bank of America Merrill Lynch wrote in a note. BofAML has a price target for Brent at $95 per barrel by the end of the second quarter 2019. In 2008, Brent spiked to nearly $150 per barrel.

The supply picture is looking increasingly worrying, with Venezuela and Iran the two principal factors driving up oil prices in the fourth quarter. Notably, the bank increased its estimate of supply losses from Iran 1 million barrels per day (mb/d), up from 500,000 bpd previously.

U.S. shale can partially make up the difference, but the explosive growth from shale drillers is starting to slow down, in part because of pipeline bottlenecks. BofAML sees U.S. supply growth of 1.4 mb/d in 2018 but only 1 mb/d of growth in 2019.

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09/25/18

Is It Really The Economy Stupid?

By: Kent Engelke | Capitol Securities

The third quarter ends on Friday. Perhaps the most significant event during the fourth quarter is the election. As I have already opined, I think this will be the most significant midterm in at least two generations.

There are two absolutes about midterms or elections. The first is the party of the incumbent president always loses seats in Congress. Over the last 21 midterm elections, the party of the sitting president has lost an average of 30 seats in the House and 4 seats in the Senate. There were only two elections the incumbent party gained seats in both houses; 1934 and 2002.

The second absolute is people vote their pocketbooks. If the economy is strong, social issues are less paramount.

The election is in about six weeks. The polls are suggesting a “Blue Wave” partially predicated upon the traditional outcome of midterms and partially from the perceived vitriol towards the president from both parties.

What are the odds Congress does not change power? What are the odds the Republicans gain seats?

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