06/22/17

Life Is Stranger Than Fiction

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.

06/21/17

Welcome To The First Day Of Summer

By: Kent Engelke | Capitol Securities

In some regards, yesterday was a quiet day. Oil slipped on concerns of a continuing supply glut, the NASDAQ fell about 0.50% while the Dow was essentially unchanged.

Is the NASDAQ topping out? The recent volatility may suggest a peak has been achieved. Typically, a stock/sector reaches an intermediate apex when there is a violent recovery following a moderate selloff. If a pattern of lower highs and lower lows occur, then the odds of a prolonged period of underperformance increases.

Regarding oil, oil is now in a bear market falling about 21% from its highest close for the year, on February 24th at $54.45/barrel. The vast majority of the decline has occurred since May 25th or the date that OPEC extended its production cuts until March 2018.

What will happen today?

Last night the foreign markets were down. London was down 0.62%, Paris was down 0.89% and Frankfurt was down 0.59%. China was up 0.52%, Japan was down 0.45% and Hang Sang was down 0.57%.

The Dow should open nominally lower. Oil shares have tumbled in 2017 on fears that the supply glut will persist. Oil shares now account for just 6% of the S & P 500, the least since 2004 and down from a high of 16% in 2008. Technology however is hovering around all-time highs of 27%. The 10-year is unchanged at 2.16%.

06/16/17

Is A Nascent Trend Forming?

By: Kent Engelke | Capitol Securities

Is a nascent trend forming? Three out of the last five days the largest capitalized momentum issues, which are technology shares, sold off as compared to the rest of the market. Yes, the S & P 500 technology index–dominated by four stocks–is still up a whopping 18% YTD, but it has dropped about 4% in five days.

According to Bloomberg, the NASDAQ 100, which is also dominated by the mega sized technology issues, is on the verge of breaking its fifty day moving average. It has remained above this key threshold for 131 consecutive days, the longest stretch since 1995.

In September 1995, when a 166 day run above this key level came to stop, the NASDAQ was flat for the ensuing one and three months. The only comparable run occurred in 1986. The index dropped 13% in one month and 16% three months later when this stretch of bullish ended in July 1986

The hapless Russell 2000, which was posting a 2% YTD gain last week, is essentially unchanged from that period. Individual issues however are advancing.

Yesterday, I referenced a JP Morgan report stating that 90% of investing decisions do not rely upon any fundamental analysis. Decisions are made via algorithms and size, essentially stating past performance will be indicative of future performance.

Will today be uglier than 1986, the result of total domination of the averages by a few stocks and the virtual sole reliance upon moving average lines for investment decisions?

Conversely, will everything else advance at the expense of the five mega-sized tech issues that have dominated the markets for several years, the inverse of past performance?

Three days out of five days do not make a trend but…

Oh, for what it is worth department, in the largest six-month performance difference since December 2010, it has underperformed the S & P 500 growth by almost 1,400 basis points as per Bloomberg.

What will happen today?

Last night the foreign markets were up. London was up 0.62%, Paris was up 0.71% and Frankfurt was up 0.27%. China was down 0.30%, Japan was up 0.56% and Hang Sang was up 0.24%.

The Dow should open flat. The 10-year is unchanged at 2.17%.

06/15/17

Has Skynet Arrived?

By: Kent Engelke | Capitol Securities

If extreme environments dictate a transition, a transition should be at hand. According to JP Morgan only 10% of stock trading is now done by fundamental analysis focusing upon the current and anticipated geopolitical and macroeconomic environment. In other words, there is no fundamental analysis. Passive and quantitative strategies dominate investing decisions.

JP Morgan also stated 52% of May’s equity volume was the result of high frequency trading (HFTs). The Bank also stated an incredible 98% of May’s Treasury volume was the result of HFTs and passive/quantitative trading.

Wow! Skynet has taken over the markets!

In my view, today’s environment has created incredible risks and incredible opportunities. As noted in the introductory sentence, extremes typically suggest a transition can occur at any moment.

Regarding the FOMC meeting, the outcome was largely as anticipated with the overnight rate increased by 0.25%. There was little initial market reaction. However by the close, led by the largest capitalized momentum stocks, the NASDAQ fell about 0.50%. The Dow was nominally higher.

Commenting briefly upon yesterday’s shooting in Washington, I rhetorically ask “do the times define the leaders or do the leaders define the times?” The vitriol, the animosity, the identity politics, the absence of truth on both sides of the political aisle has reached a level, a rancor that has not been experienced in a generation.

Is this the result of the proverbial generational change? I think I can write the vast majority of society is tired of Washington’s status quo. Americans know the difference between right and wrong, acknowledging that life is not always fair. Was yesterday the apex of today’s malevolence?

I hope so.

Last night the foreign markets were down. London was down 1.15%, Paris was down 1.20% and Frankfurt was down 1.18%. China was up 0.06%, Japan was down 0.25% and Hang Sang wasdown 1.20%.

The Dow should open moderately lower on what is now perceived as a a more hawkish tone from the Federal Reserve. The 10-year is off 8/32 to yield 2.16%.

06/14/17

Fed Announcement At 2:00 PM

By: Kent Engelke | Capitol Securities

It is widely expected the FOMC will increase interest rates by 0.25%, the second increase of the year. It is also anticipated “guidance” will suggest another 0.25% increase is forthcoming by year end.

I am certain there will be stories that monetary policy is tightening, that such increases are not warranted in today’s environment. I do not ascribe to this view.

I believe monetary conditions are still extremely “loose” given that excess bank reserves are gargantuan. Moreover, until the Fed drains these reserves from the system or until the central bank lifts the rates over the rate banks are able to lend these funds, conditions will remain “loose.”

Regarding inflation, year over year CPI is 2.0%. Excluding food and energy, the CPI is up 1.9%. This is up from 1.0% for the year ended May 2016. Generally speaking, the overnight rate is around the inflation rate.

Additionally, wage inflation is also accelerating at either end of the spectrum. There are a number of states mandating an increase in minimum wage. On the other end of the scale, there is considerable wage inflation in the STEM and trade industries.

About a month ago, I put forward a possible scenario that August 2017 could be the inverse of August 2008. The Federal Reserve shifted direction radically two weeks following a Fed meeting and uncharacteristically lowered the discount rate in a rare intermeeting move, stating risks on the downside vastly dwarfs risks on the upside.

Can the inverse occur in August 2017? If monetary velocity or the turnover of money accelerates sharply, the inverse can occur.

The announcement and post meeting statement will occur around 2:00 pm.

Last night the foreign markets were up. London was up 0.53%, Paris was up 0.71% and Frankfurt was up 0.96%. China was down 0.73%, Japan was down 0.08% and Hang Sang was up 0.09%.

The Dow should open steady ahead of the Fed. The 10-year is up 1/32 to yield 2.20%.

06/13/17

Yesterday Was Similar To Friday, But By A Lesser Degree

By: Kent Engelke | Capitol Securities

Technology stocks sold off another 0.5%. Energy and financial shares were essentially unchanged. At a casual glance of the headlines, consensus thinks the tech selloff is only temporary as is the gain for energy and financials. I cynically ask is the above the result of an extremely crowded trade, for such remarks are expected and are typical following a selloff in a very widely held sector and conversely in an under owned sector?

Two days does not make a trend, for only history will state if a massive transition is/was at hand.

Commenting about oil, the EIA stated yesterday proven oil reserves fell again in 2016, the second consecutive year. Net reduction was 8.2 billion barrels year over year. Moreover, capital expenditures remain lower in 2017 as compared to the same period in 2016.

As noted many times, ex-OPEC, from September 2014 to December 2016, a record $1 trillion in infrastructure cuts were announced.

As per the research firm BI Commodities, crude oil demand is increasing versus supply at the highest velocity since the global financial crisis. Moreover the 12-month average ratio of IEA oil world demand versus supply is the highest since January 2014. The low occurred in February 2016.

Two weeks ago, Bloomberg wrote energy trades were at their lowest level relative to the S & P 500 in 14 years and represent the lowest capitalization in 18 years.

Conversely, technology is at record ownership and percentage of the S & P 500.

Bloomberg writes four of the six largest holdings of mutual and hedge funds are four household technology names.

More buyers than sellers are required to trade higher. It is evident everyone owns the same few companies. The energy alone to maintain the status quo — i.e. unchanged — is incredible.

What happens if selling commences in earnest? I vividly recall the 18 month NASDAQ implosion from 2000-2002 that crushed that index by 70%. In many regards today is that era on steroids, especially relating to the few number of companies involved in the advance.

What will happen today? Will the inflation data alter views of this week’s FOMC meeting?

Last night, the foreign markets were up. London was up 0.02%, Paris was up 0.38% and Frankfurt was up 0.47%. China was up 0.44%, Japan was down 0.05% and Hang Sang was up 0.56%.

The Dow should open quietly. The 10-year is unchanged at 2.22%.

06/9/17

Perhaps Yesterday Was A Significant Day But Not In The Manner All Expected

By: Kent Engelke | Capitol Securities

The hype going into Comey’s testimony was incredible, thus suggesting a high bar for any type of shocking revelations. There were no bombshell revelations, albeit there is a ton of fodder for endless Internet and cable TV bloviating. I believe the markets interpreted Comey’s testimony as a nonevent for the simplistic reason a constitutional crisis is horrific for the economy and society. As inferred, the markets were generally unfazed by his remarks.

What I thought was of great significance was the House vote repealing the more onerous parts of Dodd Frank. I will argue Dodd Frank is a major reason why economic growth has been anemic as it stifles capital formation. Capital is the lifeblood of capitalism. As noted many times, monetary velocity or the turnover of money is at the lowest level since 1959.

Dodd Frank was fully implemented in September 2014 and the growth rate has since plummeted.

However, I believe the Animal Spirits have been uncaged because of potential regulatory repeal. This uncaging is a major reason why the Atlanta Fed increased its estimate of second quarter growth to 4.0%, the greatest growth since 3Q14.

What happens to growth assumptions if Dodd Frank is repealed in the Senate and monetary velocity accelerates? A dated Chicago Fed report stated if monetary velocity returns to 50% of its norm, the economy would expand around 6% with a 9% inflation rate.

Wow! A 6% growth rate would be equivalent to a bombshell revelation.

Speaking of potential bombshells, the Middle East is on the verge of total chaos. Qatar and Saudi Arabia square off in perhaps the greatest diplomatic feud in at least a generation. Suicide bombers strike at the heart of the Iranian Capital. Kurdistan moves toward independence and war rages in Syria and Yemen. Al Jazeera or the Islamic media outlet headquartered in Qatar reported that its entire news systems, websites and social media platform were hacked.

Was Saudi Arabia the attacker? Last month Saudi Arabia unexpectedly ended many of its austerity programs, partially the result of the “revolution” occurring in social media, with a direct reference to Al Jazeera.

Historically, any Middle East violence would cause oil prices to surge. For the last 15 months, prices have remained range bound between $45 and $55 barrel with crude today trading near the lower end of the range.

Commenting on yesterday’s market activity, the averages were nominally lower but the financials advanced, perhaps the result of the House repeal of Dodd Frank.

What will happen today?

Last night the foreign markets were up. London was up 0.59%, Paris was up 0.33% and Frankfurt was up 0.39%. China was up 0.23%, Japan was up 0.52% and Hang Sang was down 0.13%.

The Dow should open quietly higher. The 10-year is off 5/32 to yield 2.21%.

06/8/17

Will Today Be A Day Of Great Significance?

By: Kent Engelke | Capitol Securities

Today can be a day of great significance. The outcome of the British election will be known. The ECB decision will also be announced. And then there is Comey’s testimony. The newswires are declaratively stating this is perhaps the highest profile testimony in decades.

As noted the other day and according to the Real Clear Political average, President Trump’s ratings are higher than President Clinton’s ratings at this stage in his presidency. Gallup has the two tied.

President Clinton’s rating rose at the end of June. Will President Trump’s ratings follow the same path?

To write the insanely obvious, if Comey’s testimony is of great significance, Trump’s rating will fall. However, if the hearings are a nonevent and if economic activity accelerates, Trump’s rating may improve.

Against this backdrop, perhaps the only certainty to write is this… anything less than a bombshell accusation would help Trump given the hype and speculation of today’s hearings.

Many times I have commented about the immense market imbalances. I thought yesterday’s WSJ placed this imbalance into proper perspective when it stated the S & P 500 technology index—propelled by just five stocks—is up 21.1% YTD. The Russell 2000 is up 2.8%.

In my view, today’s imbalances are greater today than in 2000 and the hype surrounding NASDAQ 5000.

Will today end ugly? Janus’s Bill Gross stated the risk in the market is at the highest level since before the 2008 financial crisis, partially the result of central bank polices for low and negative interest rates that are artificially driving up some asset prices while generating little growth in the real economy.

Last night the foreign markets were mixed. London was down 0.05%, Paris was up 0.40% and Frankfurt was up 0.49%. China was up 0.32%, Japan was down 0.38% and Hang Sang was up 0.34%.

The Dow should open flat, but market direction may be influenced by a multitude of headlines. The 10-year is off 7/32 to yield 2.20%.

06/7/17

Can History Repeat Itself?

By: Kent Engelke | Capitol Securities

The Trump rally has been partially reversed. According to First Trust, the S & P 500 bank index rose 35% from November 8 through March 1. Since March 1, it is down about 9%. The S & P aerospace index advanced around 18% from election through March 1 and advanced another 4%.

The S & P 500 gained around 12.7% from the election to March 1 and is essentially flat since March 1. And then there is energy, advancing about 5% then falling about 7.5% for the same time period above.

Depending upon the index, the small cap companies are down about 10% since March.

On the other hand, the five largest technology companies in the world have rallied between 25% and 35% since January 1.

Wow! Talk about an imbalanced market.

The reason for the reversal is the belief that Trump’s pro-growth agenda has been stalled.

The greatest impetus for economic activity is job creation. According to the “The Job Openings and Labor Turnover Survey (JOLTS)” for April, the slowdown in the pace of non-farm payroll growth stems from a skills gap.

The net pace of hiring recently decelerated because of a slowdown in hiring rather than an increase in layoffs. Job opening rates match the highest on record, thus suggesting a strong mismatch in skills. A similar conclusion was made after the release of May’s labor report.

Has economic growth stalled because of Washington? Last week the Atlanta Fed upgraded their assessment of second quarter growth to 4.0% from 3.8%, the greatest growth rate since 3Q14, the quarter that Dodd Frank was fully implemented.

I will continue to argue if growth accelerates, interest rates will rise, momentum issues that thrive in a no growth environment will stall, and the smaller and value companies should advance.

This is not a radical view, but one that is steeped in historical precedence. The caveat is the massive proliferation of ETFs and technology based trading. Will there be a violent transition out of the five mega sized companies that have advanced between 25% and 35% year to date into everything else?

This is a radical thought, but did occur immediately after Trump was elected, an environment that received considerable attention.

Last night the foreign markets were mixed. London was down 0.05%, Paris was up 0.86% and Frankfurt was up 0.28%. China was up 1.23%, Japan was up 0.02% and Hang Sang was down 0.09%.

The Dow should open flat. In an escalation of Middle East violence, the Islamic state claims a rare attack on the Iranian parliament and a major shrine. According to initial reports, the attackers were Sunni extremists. At this juncture, geopolitical politics have not negatively impacted the averages. The 10-year is flat at 2.16%.

06/6/17

Was Yesterday A Harbinger Of Days To Come?

By: Kent Engelke | Capitol Securities

Markets were generally quiet yesterday. Data indicated that there is steady growth in the services industry thus bolstering confidence the economy is on a firm footing. Treasuries fell as the markets shrugged off the latest terror attack. Crude also dropped even though there was a major split in Middle East alliances.

Four of the six members of The Gulf Cooperation Council (GCC), a council primary comprised of Sunni nations, broke diplomatic relations with member Qatar over support for Shia/Iranian based Islamist terrorist groups. Simplistically speaking, Sunnis are led by Saudi Arabia and Shias are led by Iran. Qatar is now banned from air, land and sea travel in these five nations.

Is this of any significance? According to the Financial Times, the GCC was enraged that Qatar paid $1 billion to release members of the Gulf state royal family who were kidnapped in Iraq while on a hunting trip.

As noted yesterday, there is little on this week’s economic calendar thus suggesting the headlines may be the greatest factor that influences prices.

Last night the foreign markets were down. London was down 0.16%, Paris was down 0.59% and Frankfurt was down 0.75%. China was up 0.34%, Japan was down 0.95% and Hang Sang was up 0.52%.

The Dow should open nominally lower ahead of a week that can provide some sensational headlines. For example, Comey’s testimony, the British election, the ECB meeting and even more uncertainty in the Middle East. The 10-year is up 12/32 to yield 2.14%.