07/19/18

The Return Of Ludditism Via Universal Basic Income

By: Kent Engelke | Capitol Securities

I believe the mid-term elections will soon become the focus of the markets. I am certain the vitriol will rise to near unprecedented levels. The question at hand… will people listen outside of a concentrated group? Historically, the electorate votes their pocket books and if their pocket books are light, attention is then also focused upon social/cultural issues.

I would like to comment briefly upon President Obama’s remarks in South Africa. The President tentatively endorsed the idea of universal basic income (UBI). This is not the first time he’s spoken of such an initiative. UBI is a potential platform issue with some Democratic candidates.

Simplistically speaking, UBI is the government sending a check to its citizens to “provide dignity and structure and a sense of place and a sense of purpose in life,” according to Obama.

Obama, as with several others, has commented about the potential job losses because of increased technology. This is not the first time leaders focused upon technology and possible job losses in an election.

For example and perhaps most famous is the anti-technology movement led by Ned Ludd in the early 1800’s. His party was called the “Luddities” who believed technology… aka the cotton gin… was destroying jobs. The Luddites destroyed technology in an attempt to protect jobs under the simple premise that the ends justifies the means.

There are several billionaire tech barons who support UBI including Amazon’s Bezos and Facebook’s Zuckerburg. The irony is Amazon did not pay any federal taxes last year and it has been good at minimizing tax payments in Europe. Recently, Amazon vehemently fought Seattle’s employee head count tax, a tax that was deemed as a possible solution to Seattle’s growing homeless problem.

Those endorsing UBI point to Norway as a potential UBI model. The issue at hand, according to Bloomberg, is to have a fund similar to that of Norway, the US would need one totaling $33 trillion. The total net worth of all US households is $100 trillion. The wealthiest 0.1% of Americans holds 22% of the nation’s wealth according to UC Berkley.

Simplistically speaking, even a mass scale expropriation, which would be undesirable and unpopular at best, would not be enough.

Some supporters of the UBI have suggested a “Robot Tax” to pay for workers that are dislocated via technology. To write the obvious, this “robot tax” would predominately fall upon tech companies, some of which pay little or no taxes.

As noted, Amazon vehemently fought Seattle’s head count tax just as Facebook and others fought the Bay Area’s version of its head count tax.

As commented above, workers first vote their pocket book and social/cultural issues only become a primary issue if the pocket book becomes an issue.

A question at hand… will Silicon Valley’s unwavering support for progressive causes wane because of pocket book issues, aka increased taxes to pay for the causes they support vocally, but not financially?

Wow! If this does materialize, today’s tectonic change will take upon an entirely new dimension.

Radically changing topics, the markets were mixed led by gains in financials and industrials. The second day of FRB Chair’s testimony had little impact. Oil ended about 1.2% higher on conflicting interpretations of the inventory data. The 10-year was essentially unchanged.

Last night the foreign markets were down. London was up 0.17%, Paris was down 0.47% and Frankfurt was down 0.41%. China was down 0.53%, Japan was down 0.13% and Hang Sang was down 0.38%.

The Dow should open moderately lower. Some are pointing to trade concerns, others to the strengthening dollar, while others to mixed earnings reports and a strengthening economy, which signals higher interest rates. In my view, it is a combination of all the above. The 10-year is off 4/32 to yield 2.89%.

07/16/18

A Mixed Start To Second Quarter Earnings

By: Kent Engelke | Capitol Securities

There was a mixed start to second quarter earnings. Some have attempted to draw broad based conclusions, however, I think such is fruitless if not impossible. Perhaps the only concrete comment to make is earnings must exceed expectations so as to not be punished. Such may be the case for the market leaders because according to RBC, on almost every valuation variable, they are priced at record multiples, a record by a wide margin.

Changing topics, trade tensions are simmering just below the surface. China’s monthly trade surplus with the US rose to a record in June and exports to the nation also soared, underlining the cause of the escalating trade war. What trade headlines will be made this week?

The economic calendar is comprised of several manufacturing statistics for housing data in the Beige Book. Little reaction is expected.

Commenting about Friday’s market action, equities were mixed. Technology was flat to down, but energy/industrials were up.

Last night the foreign markets were mixed. London was down 1.13%, Paris was down 0.38% and Frankfurt was down 0.13%. China was down 0.61%, Japan was closed for a holiday and Hang Sang was up 0.05%.

The Dow should open flat. The 10-year is off 2/32 to yield 2.84%.

07/12/18

Trade Induced Selloff

By: Kent Engelke | Capitol Securities

Many times I have commented about the narrowness of the markets citing the WSJ, Barons, etc. All know the statistics. The entire 2018 gain in the S & P 500 is the result of 4 stocks, one of which is up about 48% YTD and is now the third largest company in the S & P 500, representing about 38% of index’s 2018 gain. Another is up about 112% and about 18% of the S & P 500 return.

Yesterday, PIMCO commented about this narrowness. Writing today that it is the most crowded trade in at least a generation, perhaps in history. PIMCO further writes the market is in a more difficult situation than most believe because of this narrowness and there is a distinct probability an event will shatter the illusion of liquidity (and safety) in the markets.

This narrowness is gaining momentum because of market mechanics that focus upon size, speed and cost of execution. It is a massive snowball gaining momentum, completely out of control, inferring perhaps nothing can stop it until it comes to a climatic end.

These remarks are similar to those that have been made by other bulge bracket firms, but what I found interesting is that PIMCO used NFLX as an example.

NFLX is up about 112% YTD, following a 55% gain in 2017 and is the twenty-fifth largest member of the S & P. It is one of the four companies that comprise the S & P’s 2018 YTD gains.

PIMCO writes NFLX is trading at 7x EBITDA (earnings before interest, taxes, depreciation and amortization). It is $6 billion in debt, $5.5 billion of which was raised during the past five years, spending $4 billion of this amount. It is not expected to be “cash flow positive” for at least another five years.

Generically speaking, companies trading with such metrics are viewed as firms in “financial distress” and are possible candidates for restructuring if performas’ are not met.

Wow!

Many times I have commented the markets are devoid of macroeconomic, geopolitical and security analysis. Approximately 90% of investing decisions are made by using momentum as the primary indicator, defined as algorithmic and passive/indexing strategies.

As PIMCO writes, there is a strong probability that today will end, but the question is when and how much carnage will ensue.

I find that poor performance of “quant funds,” or funds that slice and dice equities based on traits like profitability and price volatility as compared to the rest of the market, are thus experiencing their worst year in eight years. They are vastly underperforming in the markets posting near double digit losses. This trade is popular and is/was viewed as a conservative strategy. As inferred, it is a crowded trade and when trends change, buyers can be sparse.

Pivoting to inflation, the PPI rose by the greatest amount since November 2011, exceeding expectations. The data suggests that inflationary pressures are becoming more embedded at the producer level, but the question at hand is whether or not these increased costs can be passed onto the consumer. If they can’t, margins can suffer. If they can, monetary policy assumptions may be yet again questioned.

Today’s CPI data can offer some insight into this question.

Commenting about yesterday’s market activity, equities declined moderately amid renewed tensions over trade and geopolitics. Oil fell the most in two years even though inventories fell by the greatest amount since September 2016 and overall inventories are at levels last experienced in February 2015. Trade woes were blamed for the selloff in crude.

What will happen today?

Last night the foreign markets were up. London was up 0.79%, Paris was up 0.80% and Frankfurt was up 0.61%. China was up 2.16%, Japan was up 1.17% and Hang Sang was up 0.60%.

The Dow should open moderately higher on a subtle shift in Chinese trade attitude to one of possible compromise. Oil is rebounding as the IEA stated output in OPEC is stretched to the limit and may have difficulty in supplying losses elsewhere in the group. The 10-year is off 4/32 to yield 2.87%.

07/9/18

Strong Jobs Data

By: Kent Engelke | Capitol Securities

In my view, June’s employment report was strong. Non-farm and private sector payrolls growth was greater than expected. Prior months’ gains were revised higher. Hiring in the manufacturing sector is at the fastest pace since 1998.

The unemployment rate rose to 4.0% from 3.8%, the result of more workers entering the work force. The increase in the labor participation rate to 62.9% from 62.7% is further evidence of workers reentering the workforce, the greatest participation since 2009. Historically, the LPR is around 66.5%-67%. This reentry of workers however is serving as a governor on wages as wage growth was slightly lower than expected.

I believe the data is the clearest indication the economy has finally reached the proverbial “escape velocity” inflection point or the juncture where growth is over a 3.0% sustainable rate.

Markets responded favorably to the data, ignoring the ongoing trade drama.

Radically changing topics, Bloomberg commented there is a massive slowdown of funds going into both mutual funds and ETFs. The newswire reported Vanguard — the world’s second largest money manager — collected 42% less money in both actively managed mutual funds and passive ETFs during the first six months of the year… $138 billion down from $237 billion. Wow!

Bloomberg further wrote total US funds flows — money going into exchange traded, active and passive mutual funds — fell by 50% [$200 billion versus $400 billion] as compared to the same period of 2017.

Wow! It is apparent the vast majority of funds — both new and existing — have gravitated to just four companies. Last week I referenced Goldman’s research stating four companies accounted for 88% of the S & P 500 gains. One company contributed 36% of these gains and another 18%. These companies are posting a 47% and 111% 2018 advance.

The companies referenced above are not explosive growth small capitalized companies. One is the third largest company in the S & P 500, while the other is the twenty-fifth largest entity. The increase in value of these two companies in 2018 is unfathomable… approximately $500 billion.

As noted above, total new 2018 funds in active and passive mutual funds was $200 billion. Wow! What myopicy!!!

Earnings season commences later this week with the release of several money center banks. How will the results be interpreted? Analysts are expecting a 20% increase in profits and a 9% gain in revenues.

Last night the foreign markets were up. London was up 0.28%, Paris was up 0.29% and Frankfurt was up 0.02%. China was up 2.47%, Japan was up 1.21% and Hang Sang was up 1.32%.

The Dow should open nominally higher as attention is now beginning to be focused upon earnings. The 10-year is off 8/32 to yield 2.86%.

07/2/18

Welcome To The Second Half Of 2018

By: Kent Engelke | Capitol Securities

Welcome to the second half of 2018. Thus far, 2018 has been the year of surprises. Bitcoin is down 70% from its late 2017 apex. Oil at $74/barrel is at a 3 /1/2 year high versus the consensus view of $45/barrel.

Second quarter GDP is expected to be in the “high four handle” versus the projected “low two handle.” The PCE or the Federal Reserve’s preferred inflationary indicator is at the highest level since March 2012, again eclipsing expectations. Accordingly the 10-year Treasury at 2.85% yield eclipsed the 2.50% mid-year target. Four interest rates are now expected versus two.

And then there is equity performance. The NASDAQ has continued its relentless advance, but the advance is predominately focused in just five names perhaps creating the most concentrated amount of wealth in history. The S & P 500 and Dow are essentially flat.

Geopolitically, economic nationalism and populism has replaced globalism and interdependency. On January 1, “the experts” declared economic nationalism as dead; a flash in the pan.

Today is vastly different than yesterday, a differentiation that I believe is not yet manifested in the markets, perhaps the result of the massive proliferation of passive algorithmic and index trading that now comprises 90% of the volume. Such trading is based upon momentum and size not macroeconomic/geopolitical and security analysis.

On January 1, 2019, what will I be writing? In my view, because of the tectonic changes in the geopolitical and macro-economic landscape, a macroeconomic and geopolitical thesis is required, further stating the days of passive investing/indexing are waning. This is the inverse of the last 10 years.

At this juncture, I will not opine about the election other than I believe the support for the president and his policies is much greater than the media — both traditional and social — suggests.

Few will risk speaking true views under fears of being labeled homophobic, xenophobic, unenlightened and uneducated individuals. The president is challenging the establishment, an establishment which the business and political elite have spent billions in creating and maintaining.

This is holiday shortened trading week. June’s unemployment data is released Friday and will offer evidence as to the economy’s underlying strength. Historically, voters vote by their pocketbooks and the data could offer some potential insight into November’s elections.

Last night the foreign markets were down. London was down 0.83%, Paris was down 0.79% and Frankfurt was down 0.33%. China was down 2.52%, Japan was down 2.21% and Hang Sang was closed for a holiday.

The Dow should open lower on trade and geopolitical concerns. A major question at hand will be whether the accepted leader and cheerleader of the EU — Chancellor Merkel of Germany — survive? Many believe if her coalition — which is on the verge of collapsing because of immigration — fails, it will question the survivability of the EU in its current state. We are indeed living in tectonic times. The 10-year is up 7/32 to yield 2.84%.

06/29/18

The Saudis Won’t Prevent The Next Oil Shock

By: Nick Cunningham | Oilprice.com

Saudi Arabia is starting to panic, and is growing concerned that the growing number of supply disruptions around the world could cause oil prices to spike. Saudi Arabia is moving quickly to head off a supply crunch, aiming to dramatically ramp up production to a record high 11 million barrels per day in July, according to Reuters.

The increase, if it can be pulled off, would be an incredibly rapid ramp up in output, up more than 1 million barrels per day (mb/d) from May levels.

How this plan fits into the latest OPEC+ deal remains to be seen. It was only a few days ago that Saudi Arabia and its coalition partners said that they would add 1 mb/d of supply back onto the market, with many of them acknowledging that, in reality, the figures would be closer to 600,000 bpd because of the inability of so many producers to ratchet up output.

As such, the addition of 1 mb/d from Saudi Arabia alone would lead to the OPEC+ group exceeding the production levels they just committed to, after factoring in additions from Russia and other Gulf States.

However, the surge in output does not need to exported, at least not right away. Saudi Arabia could divert extra barrels into storage. Moreover, higher output is needed during summer months anyway because the country burns oil for electricity, which spikes amid hot summer temperatures. So some of the extra production will be consumed domestically.

Still, an industry source told Reuters that the increase in output “will go to the market,” although the details are unclear. Bloomberg reports that shipments from Saudi Arabia to Aramco’s overseas storage facility in Egypt have already been on the rise this month.

“We already mobilized the Aramco machinery, before coming to Vienna,” Saudi oil minister Khalid al-Falih said over the weekend.

The dramatic ramp up in production suggests that Riyadh wants to prevent prices from rising too much. Producing at 11 mb/d will help offset the outages in Libya, Venezuela, Nigeria, Canada and Iran, but it might not be enough. The U.S. State Department said on Tuesday that Washington would take a hardline towards countries importing Iranian oil. The Trump administration expects countries to zero out Iranian oil imports by November 4, and the State Department said it would be unlikely that anyone would be granted a waiver.

That raises the odds of a much more serious outage from Iran than previously expected. Some analysts put the potential outage at 1 mb/d or more. If the U.S. is successful at convincing most countries to stop buying oil from Iran, the outages could rise to as high as 2 mb/d, although that remains speculation.

In another sign of how unpredictable the oil market has become, Kazakhstan lost 240,000 bpd this week, due to an unknown cause.

In this context, Saudi Arabia producing at 11 mb/d is probably needed, and it still might not be enough.

Worse, ramping up to 11 mb/d significantly cuts into available spare capacity. Estimates vary, but Saudi Arabia may have the ability to produce as much as 12.5 mb/d, although perhaps less. That means producing at 11 mb/d leaves only up to 1.5 mb/d of spare capacity. Add in smaller contributions from elsewhere and global spare capacity might only amount to 2 mb/d of supply as of July, or only about 2 percent of total global production. That would be down from about 3.0 to 3.5 mb/d up until recently.

“It basically leaves us with no spare capacity, at a time when Iran isn’t the only issue,” Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd., said in a Bloomberg television interview. “Venezuelan production’s falling, Angola, Libya, Nigeria –there are lots and lots of issues everywhere in the world.”

Unless demand falls back, or some of these outages dissipate, oil prices could be heading much higher.

By Nick Cunningham of Oilprice.com

Link to original article: https://oilprice.com/Energy/Energy-General/The-Saudis-Wont-Prevent-The-Next-Oil-Shock.html

06/28/18

A Market Reversal… Surging Crude… 5% 2Q GDP GROWTH

By: Kent Engelke | Capitol Securities

Declines in technology shares led a market reversal. Comments from an official at the White House reestablished the hard line stance towards China. Earlier in the day the S & P 500 was posting a 0.9% advance on remarks from the president suggesting a softening of positions. The S & P closed down about 0.86%.

As noted the other day, technology companies derive 59% of their sales from abroad, greatly eclipsing the percentage of sales from the next largest category — the industrials — at 38%, thus suggesting any change in policy may have a considerable impact.

Changing topics, oil further added to its gains closing at a 3 ½ year high of $72.50/barrel. Markets were spooked by the realization that there is little excess global spare capacity. As noted earlier, Saudi Arabia is the only country that has any significant excess capacity and once the planned increase in production commences, Saudi’s reserves will decline by 40%.

Bloomberg writes excess capacity will then be at an all-time low, thus suggesting little ability to respond to further disruptions.

For many years, a geopolitical premium was absent in crude believing supplies are infinite. Will the environment now radically change where a large geopolitical premium becomes embedded?

There was little attention focused upon rising forecasts of second quarter GDP growth. The Atlanta Fed just increased its estimate to 4.5%. Several other forecasters boosted views to 5%. The only time growth has topped 5% since 2003 was the third quarter of 2014 when the economy grew by 5.2%.

I believe a major factor why the economy did not achieve “escape momentum” four years ago was the result of the full implementation of Dodd Frank which made capital formation — the lifeblood of capitalism — extremely difficult.

As largely discussed, some of the provisions of Dodd Frank have been rolled back.

What will happen today?

Last night the foreign markets were down. London was down 0.21%, Paris was down 0.58% and Frankfurt was down 1.08%. China was down 0.93%, Japan was down 0.01% and Hang Sang was up 0.50%.

The Dow should open steady as all are attempting to grapple with America’s strategy towards Chinese trade and investment. Emerging markets had another miserable day, a sector class that could do no wrong up to three months ago. Crude is nominally higher. The 10-year is unchanged at 2.83%.

06/26/18

A Technology/Trade/Interest Rate Sell Off

By: Kent Engelke | Capitol Securities

Led by technology, equities had their worst day since early April broaching key technical levels. According to Bloomberg, the Dow closed below its 200 day average for the first time in 500 days. Will the selling continue as second quarter earnings season quickly approaches?

Some are making the point the current selloff is unique given that profit estimates are rising. Several months ago, I opined the averages could fall even as earnings increase because of a change in monetary policy, specifically stating the impact as to when the yield of the six month treasury exceeds that of the S & P 500. Historically when this occurs, volatility rises. The six-month Treasury is today yielding 2.08% versus a 1.93% yield for the S & P 500.

Most attributed yesterday’s selloff to trade tensions. I too share this view, but also believe changing monetary policy is contributing to recent declines. Interest rates are the largest component of valuation formulas.

I must also write the largest dollar companies have the greatest impact upon the averages. When shares fall, the losses are magnified.

Bloomberg writes the proverbial four FANG stocks outpaced the market by 14 times this year and tumbled 3.8% yesterday, wiping out more than $70 billion in market value. In other words, the stocks that had the greatest performance thus far in 2018, suffered the greatest fall yesterday. Is this a harbinger of things to come?

I must write a $70 billion decline is a rounding error as the four companies mentioned are worth over $2.4 trillion.

What will happen today?

Last night the foreign markets were mixed. London was up 0.57%, Paris was up 0.40% and Frankfurt was up 0.18%. China was down 0.52%, Japan was up 0.02% and Hang Sang was down 0.28%.

The Dow should open nervously flat. Oil is higher on supply concerns. There is a growing consensus that OPEC, et.al. cannot meet demand because of lack of infrastructure spending, geopolitical strife and unplanned outages. Six weeks ago, the consensus was the inverse… supplies would again overwhelm demand. The 10-year is unchanged at 2.88%.

06/13/18

Fed Statement At 2:00

By: Kent Engelke | Capitol Securities

There is a small cadre of economists who believe the economy is on the verge of shifting into a higher gear perhaps growing in excess of 4% per annum, the first such occurrence since 2003. In the late 1990s, there were 4 consecutive years of 4% growth

The reasons for this optimistic outlook are tax cuts that increases productive capacity, a freeze and perhaps possible roll back of many onerous regulations enacted over the past 10 years, the number of job openings exceeding the number of job applicants the result of small business formation and finally small business confidence rising to the second highest level ever.

Twenty years ago, during the last era of strong capital spending that enabled the economy to expand at a 4% per annum rate for over 4 years, 90% of all job creation occurred in small businesses defined as companies employing 400 people or less.

During the past 10 years, the two major concerns of small business were regulation and lack of pricing power. Commenting about regulation and the long arm of government, for the first time in history, 2011 marked the first year small businesses stated government, not economic risk, was their greatest fear. It has since remained, but the percentage has dropped considerably.

Wow! Perhaps this is the single biggest reason why economic nationalism and populism is sweeping the country; contradicting statements from the educated elite dictating to the electorate in what to believe.

Regarding pricing power, the number of small businesses planning to raise prices is at a 10 year high and a record 35% of small companies are reporting higher compensation.

The two day Federal Reserve meeting concludes at 2:00. All are expecting another 0.25% increase. What comments will the Committee make about expected growth and inflationary pressures? Will any of the remarks resemble those of above?

Commenting about yesterday’s market action, markets were mixed. North Korea was a market nonevent, Brexit is still alive and there was little new on the trade front.

Last night the foreign markets were mixed. London was up 0.46%, Paris was up 0.33% and Frankfurt was up 0.38%. China was down 0.97%, Japan was up 0.38% and Hang Sang was down 1.22%.

The Dow should open firm, but all will focus on the FOMC’s comments as recent inflation statistics have reignited speculation that there could be a total of four increases in 2018. The 10-year is up 2/32 to yield 2.96%.