03/24/17

ULTIMATLEY IT WILL BE ABOUT EARNINGS AND INTREST RATES

By: Kent Engelke | Capitol Securities

Healthcare has become the litmus test as to whether Trump could legislate his agenda. Because of technology based trading where variables and responses to these variables are preprogrammed, market reaction may be greater than it otherwise should.

Unfortunately this is the environment that has evolved; an environment that I believe is on the cusp of change given the breakdown of cross correlated trading models that have worked almost flawlessly for almost 10-12 years.

Some believe these models could/would evolve into SkyNet, the all-powerful computer system that John Connor had to destroy to save the world.

I do not share this view for the simplistic reason that all trading models ultimately fail via their own demise. The trade becomes “overcrowded” with all replicating the same strategy. Change is the only constant and over time markets will respond accordingly to the macroeconomic and geopolitical environment as well as earnings and interest rates, the appropriate driver of equity and bond prices.

Commenting about yesterday’s market action, all markets were relatively unchanged even as the healthcare vote was delayed for at least a day.

Last night the foreign markets were mixed. London was down 0.10%, Paris was down 0.41% and Frankfurt was down 0.17%. China was up 0.64%, Japan was up 0.93% and Hang Sang was up 0.13%.

The Dow should open nervously quiet ahead of the potential healthcare vote. The 10-year is unchanged at 2.42%.

03/21/17

A CONFLICTING ENVIRONMENT

By: Kent Engelke | Capitol Securities

For many, things are not making sense. President Trump’s approval ratings hit a new low, but both personal and corporate confidence is surging, the result of Trump’s anti-tax and anti-regulatory attitude. It is obvious many are celebrating the possible demise of the administrative state.

According to the WSJ, for the first time in many years, the 10-year Treasury is now yielding considerably more than the S & P 500 dividend yield… 2.5% of the 10-year versus 1.9% for the S & P 500. For many, this too does not make sense, suggesting that either yields or the S & P 500 is poised to tumble.

Speaking of tumbling, the S & P 500 yesterday did not tumble, but did slip about 0.20% while the other indices were essentially unchanged. The accepted reason… trade concerns.

Continuing with the “conflicting theme,” there are divergent statements from FOMC officials regarding monetary policy. I have little concern about opposing views for typically crises occur when there is “group think” and differing opinions are not voiced fearing political and other ramifications.

What will happen today?

Last night the foreign markets were mixed. London was down 0.17%, Paris was up 0.26% and Frankfurt was up 0.01%. China was up 0.39%, Japan down 0.34% and Hang Sang was up 0.37%.

The Dow should open quietly higher. Three Fed officials speak today. Oil is up about 1% on the belief that inventories contracted for the second consecutive week. The market is now suggesting a 57% chance of an another interest rate hike by June. The 10-year is off 6/32 to yield 2.49%.

03/20/17

WHAT WILL THIS WEEK’S HOUSING DATA SUGGEST?

By: Kent Engelke | Capitol Securities

Treasuries advanced last week, the first of several; following the Federal Reserve’s signal that it is not in any rush to lift rates. Oil prices however had the first weekly gain this month following an unexpected reduction in inventories and from Saudi Arabia’s comments that it may prolong production cuts into the second half of 2017. Equities ended the week nominally higher.

Several weeks ago, I quoted a WSJ journal article about the breakdown of the cross correlated trade, a trade that almost everyone is involved in as it has worked almost flawlessly for the last 10-12 years.

In my view — a view at this juncture is entirely rhetorical and conjectural — the last two weeks it has appeared that the trade is back in vogue. Or perhaps the more accurate statement to make is velocity of the trade has returned.

Oil and Treasuries were crushed, with the latter rallying sharply last week. Will oil follow suit this week, perhaps the result of falling inventories and bullish statements from the oil producing countries?

If oil does advance, will this squash the rally in Treasuries for such is historically viewed as inflationary?

Because of the tectonic change in trading mechanics, the massive influence of ETFs and algorithmic trading, trends that typically took months to unfold, now occur in a matter of days. A case can be made that such trends mask the real volatility beneath the surface, volatility that only benefits a few.

The economic calendar is sparse until the end of week. Data released include new and existing home sales, durable goods orders and several regional manufacturing indices.

Speaking of housing, will the dearth of homes available for sale increase inflationary pressures? As noted many times, since 2008 new home construction is about two-thirds the level to meet innate demand, the result of crushing regulation. Moreover, the inventory of unsold existing homes is also around record lows.

Will the acceleration in home prices, the result of the lack of inventories, begin to increase owners’ equivalent rent (OER) or what someone thinks they could rent their home for if it was indeed a rental? OER is closely correlated to home values, it plunged in 2008 and has been benign for a myriad of reasons.

Apartment rents are surging because of the lack of housing inventories. There is a debate… does OER follow apartment rents or vice versa?

OER represents between 30% and 35% of the accepted inflationary indices. I will continue to argue if OER suddenly accelerates, the odds of which I think are over 75%, inflationary expectations may become unanchored.

Wow! Such would make the recent drubbing in the bond market as benign an environment that will be acerbated by the proliferation of ETFs and technology based trading.

What will happen today and this week? There is a plethora of Fed speakers this week. Will the narrative be any different than the one expressed by the FRB Chair last Wednesday?

Last night the foreign markets were mixed. London was down 0.18%, Paris was down 0.30% and Frankfurt was down 0.31%. China was up 0.41%, Japan closed for a holiday and Hang Sang was up 0.79%.

The Dow should open nominally lower. The 10-year is off 2/32 to yield 2.52%.

03/17/17

A POTENTIALLY DRAMATIC WEEK IS ENDING ON A WHIMPER

By: Kent Engelke | Capitol Securities

Trades sparked by the FOMC’s dovish tone partially unwound yesterday as stocks slumped and Treasury yields edged higher following an 11-point pre -FOMC tumble.

The Treasury market was spooked by the Bank of England’s comments that it is closer to raising rates than previously expected. It is thought American growth will drive demand abroad.

There was some attention focused on the President’s 2018 budget, where historically deep budget cuts are proposed, touching almost every federal agency and program and dramatically reordering government priorities.

I am certain the bureaucracy will vehemently fight the reduction of the Administrative State, a state that grew exponentially over the last eight years and has stifled growth and invention.

Generally speaking, the events/statistics of this week were largely as expected, a week that could have been of great significance producing considerable volatility.

First quarter earnings season commences in about three weeks. The economic calendar is “relatively light” until the first week of April. Will markets become quiet until that juncture?

Last night the foreign markets were mixed. London was up 0.16%, Paris was up 0.33% and Frankfurt was up 0.08%. China was down 0.96%, Japan was down 0.35% and Hang Sang was up 0.09%.

The Dow should open flat. The G-20 is meeting this weekend, the first gathering of the largest 20 economic nations attended by the Trump administration. Will there be any significant events? The 10-year is up 6/32 to yield 2.52%.

03/16/17

NO CHANGE IN THE MONETARY TIMETABLE

By: Kent Engelke | Capitol Securities

As expected, the Federal Reserve raised its benchmark lending rate a quarter of a point and continued to project two more increases this year. A minority had thought that the committee would suggest three increases as possible in 2017 given sentiment and employment levels.

Because the monetary timeline was left unchanged, stocks advanced and Treasuries surged. The dollar fell and oil rallied.

Commenting on the Treasury market, was the advance fueled by short covering, the result of the committee leaving its 2017 and 2018 forecasts unchanged? All must remember that over 90% of the trading in the Treasury market is the result of algorithmic or technology based activity.

One can make the case because of the strong advance in Treasuries, more than a minority expected the Fed to change its monetary policy timetable and expectations.

As also indicated, oil gained over 2.25%, the result of a falling dollar and inventory levels. Inventories have been growing over the preceding weeks, growth I believe was the result of OPEC’s decision to pump all out in the months leading to the January 1 production cut.

I had verbally commented that inventories may be on the verge of declining because it historically takes about 45-60 days to ship the oil once pumped, thus suggesting the current production glut is in its final hours. The International Energy Agency (IEA) echoed a similar view Tuesday evening.

I also verbally remarked about falling super oil tanker rates, down about 45% from January 1, the result of empty tankers sitting idly with no charter rates. For about 30 months, tanker rates were achieving consecutive record highs, the result of strong demand from OPEC countries. Are falling tanker rates a harbinger of falling inventories? Logic and history suggest yes.

What will happen today?

Last night the foreign markets were up. London was up 0.92%, Paris was up 0.67% and Frankfurt was up 0.84%. China was up 0.84%, Japan was up 0.07% and Hang Sang was up 2.08%.

The Dow should open nominally higher. Oil is up on inventory drawdowns, the FOMC’s dovish message and a pro-European victory in the Netherlands. The 10-year is off 8/32 to yield 2.52%.

03/15/17

NO ONE CAN MAKE UP TODAY’S NARRATIVE

By: Kent Engelke | Capitol Securities

Where to? Today can be a significant day given the Netherlands referendum, the Fed meeting and the continued diplomatic issues between two NATO allies — The Netherlands and Turkey.

Regarding Fed policy, the markets are expecting a 0.25% increase in the fed funds rate and have fully discounted an additional 0.50% increase by year end. Will FRB Chair Yellen suggest policy that may become more hawkish during the press conference? Yes, if the data suggests that such policy is appropriate.

What are the odds of such? Many times I have mentioned surging consumer and small business sentiment. Yesterday, Bloomberg reported that optimism from CEOs jumped by the greatest amount since the end of 2009. I think this is significant.

The largest companies have fully supported the globalist environment. As inferred above, globalism can be on the cusp of yet another setback and thus begets the question of why the surging optimism by the largest companies?

According to Bloomberg, these leviathans are encouraged by Trump’s plays: cutting taxes, reducing regulations and investing in infrastructure. Jamie Dimon, CEO of JP Morgan, stated the animal spirits after being caged for the past eight years have been released.

Several times during the campaign, I referenced a NYT article indicating not a single CEO of an S & P 100 company endorsed Donald Trump. Have attitudes changed?

If so, and if sentiment continues to remain robust by both the consumer and small business owners, I would expect more hawkish comments by the FRB Chair in the intermediate future.

What will happen today? Will trading be muted until the 200 PM Fed announcement?

Last night the foreign markets were mixed. London was up 0.19%, Paris was up 0.13% and Frankfurt was up 0.02%. China was up 0.08%, Japan was down 0.16% and Hang Sang was down 0.15%.

The Dow should open nominally higher. Oil is up about 2% on an unexpected drawdown in inventories. The 10-year is up 5/32 to yield 2.58%.

03/13/17

IN MY VIEW IT IS ALL ABOUT THE LABOR PARTICIPATION RATE

By: Kent Engelke | Capitol Securities

Employers added jobs at an above average pace for a second month. The 235,000 increase followed a 238,000 rise in January that was more than previously estimated and was the best back to back rise since July.

Some are discounting the rise because of the unseasonably warm weather, but the data does coincide with a surge in economic optimism following Trump’s victory.

The labor participation rate (LPR), which I believe is a good proxy of the strength of the jobs market, also rose, rising to 63.0%, the highest participation rate since December 2013. The LPR was 62.6% in November.

This data all but ensures the Federal Reserve will increase rates next week.

Commenting further on the LPR, the LPR was around 66.1% in 2008. It was on a downward trend since reaching a 45-year nadir of 62.5% in November 2015 and has remained in this zone since then. A strong case can be made that the vast majority of the drop in the unemployment rate from 10% to 4.7% was the result of the plunging LPR as there are less workers in the workforce, thus a lower unemployment rate. It is estimated that if the LPR was around 2008 levels, the unemployment rate would be about 9%.

The prime age participation rate (people aged 25-54) rose to 81.7% up from 80.6% in September 2015, which matched the lowest since 1984.

Has the trend reversed itself? The answer to this question is pivotal regarding monetary policy and interest rates and perhaps equity performance.

A case can be made that wage gains may remain modest (as was the case in both January and February’s data) because of this huge pool of labor which will permit the FOMC to maintain more of an accommodative policy than the headline data may otherwise suggest.

As noted many times and as indicative by every business and consumer sentiment survey, optimism is surging because of the election. Is this change in sentiment — aka the unleashing of animal spirits that have been caged since 2008 — going to translate into increased activity and capital formation that permits greater growth than anticipated?

If annual growth accelerates to over 3% for the first time in 10 years, the Trump administration may be viewed in the same light as General Patton, the abrasive general who was instrumental in defeating Hitler.

To place this anemic growth into perspective, according to the Bureau of Economic Analysis, this is the first time since record keeping commenced in 1929 that the economy did not grow at 3% or higher for one year in a 10-year stretch.

This record shattered the previous record of four year from 1930-1934.

If growth does accelerate to over 3% for a myriad of reasons, there is great potential that Main Street will outperform Wall Street.

To remind all, the last time Main Street did outperform was in 2005, the last year annual growth was over 3%. The US expanded by 3.3% during 2005.

Because of the data, fed funds futures are now suggesting a 30% chance of four interest rate hikes in 2017. Wow! This is the first time in over ten years the market is perhaps suggesting more hikes than thought on January 1.

Markets closed nominally higher on the news.

What will happen this week? The Fed meeting concludes Wednesday; there is a host of inflation data, retail sales statistics, consumer confidence and housing information as well as a key vote in the Netherlands which may further impinge globalism.

Last night the foreign markets were up. London was up 0.25%, Paris was up 0.09% and Frankfurt was up 0.07%. China was up 0.76%, Japan was up 0.15% and Hang Sang was up 1.11%.

The Dow should open flat ahead of a busy week. The 10-year is up 1/32 to yield 2.58%.

03/10/17

JOBS DATA AT 8:30 AM

By: Kent Engelke | Capitol Securities

The February BLS employment report is released at 8:30 am. Most are expecting the data to be robust for a myriad of reasons including the generational low in weekly jobless claims, the ADP employment report and the strongest consumer and business sentiment in over 15 years

Most believe this report will be the basis for a rate increase next week and some are suggesting the data could be the catalyst to a more hawkish monetary policy position.

Analysts are expecting a 4.7% unemployment rate, a 200k and 210k increase in nonfarm and private sector payrolls, respectively, a 0.3% increase in hourly earnings, a 34.4 hour workweek and a 62.9% labor participation rate (LPR).

I believe the most important components of the report will be the LPR and hourly earnings. To date, earnings growth has remained subdued, perhaps the result of a generational low LPR.

I think if the LPR and hourly earnings surprise on the upside, a considerably more hawkish monetary policy stance will evolve. By every benchmark, even if the overnight rate is increased by the consensus view of 0.75% during 2017, monetary policy will still be regarded as very simulative.

Commenting about yesterday’s market action, oil fell below $49 for this first time this year almost sending equities to its fourth consecutive decline if it were not for a late recovery. Treasuries sank a ninth consecutive day as the ECB expressed optimism on global growth and inflation. The 2-year treasury, or the instrument most sensitive to monetary policy, rose to the highest yield in seven and half years.

Last night, the foreign markets were up. London was up 0.50%, Paris up 0.52% and Frankfurt up 0.57%. China was down 0.12%, Japan up 1.48% and Hang Sang up 0.29%.

The Dow should open moderately higher ahead of the jobs data, but this could change radically if the statistics differ greatly from the consensus view. The 10-year is unchanged at a 2.60% yield, oil is up about 1%.

03/8/17

WILL THE COMPLACENCY IN THE BOND MARKET BE SUDDENLY SHATTERED?

By: Kent Engelke | Capitol Securities

In my view, consensus now believes 3% plus growth is gone forever, interest rates will remain around current levels until eternity and secular stagnation will be the everlasting buzz word.

The bond market has been in a thirty year bull market and after almost eight years of slow and anemic growth in the face of massive global stimuli, it is no wonder the above is perhaps the consensus view.

But is this about to change? I can write volumes about the Global Establishment and its propensity to redistribute wealth via tax and regulatory policy. I can slow write volumes about The Electorate who is rising up against the Establishment, as evidenced by Brexit, Trump, Italy and perhaps now France and The Netherlands.

Change is the only constant. Vitriol and animosity accompanies change as old power bases are destroyed and new ones created.

Friday, the all-inclusive BLS labor report is released. Historically, a 4.8% unemployment rate is inflationary. To date, wage inflation has been virtually nonexistent. Is this result of an anemic labor participation rate (LPR)? I must write there is wage inflation on either end of the spectrum.

Will wage inflation accelerate if growth rises to the level that the vast majority of the sentiment surveys and infusion indices are suggesting? If wage inflation does occur, I will opine the complacency in the bond market will be shattered.

In my view, because of technology, ETFs and Dodd Frank, liquidity is challenged in many parts the bond market. Perhaps the only certainty to write is if growth and inflation surprises on the upside, bond market complacency will be shattered.

Trading yesterday was quiet with most markets insignificantly lower.

Last night the foreign markets were mixed. London was down 0.19%, Paris down 0.04% and Frankfurt up 0.12%. China was down 0.05%, Japan down 0.47% and Hang Sang up 0.43%.

The Dow should open quiet ahead of perhaps a great transition in monetary policy. The last rate cycle was 11 years ago. Wow! Considering the dramatic changes in the bond market, perhaps amplified by the dearth of experienced participants, it may be a rude awakening. The 10-year is off 7/32 to yield 2.55%.

03/6/17

DID FRB CHAIR YELLEN TELEGRAPH A STRONG LABOR REPORT?

By: Kent Engelke | Capitol Securities

Did FRB Chair Yellen telegraph a strong labor report for Friday? Yellen commented “an interest rate increase would be appropriate at the central bank’s upcoming meeting if employment and inflation continue to meet policy makers’ expectations.”

Fed funds futures, which are a gauge of market sentiment, are now suggesting a 96% chance of interest rate increase on March 15. Seven days ago the odds were less than 40%.

As noted the other day, the markets have now discounted three interest rate increases for 2017, the amount the Committee suggested in late 2016. I do think it is noteworthy that at the start of 2016, central bankers expected to make four rate increases, but only did one and that was in December.

Because of these missed outlooks, many have become complacent about the risks within the sovereign debt markets; risks that I think are substantial. Several weeks ago, I opined about the possibility of more rate increases than expected because of stronger growth, the result of uncontained “animal spirits;” animal spirits that have been caged for over eight years because of regulatory zeal and crushing tax policies. This zeal/policy has now been perhaps caged if not reduced.

Is market focus now switching from attention to Trump’s proposals to data and how this data will affect monetary policy? This week is a heavy data week and if the markets respond to these statistics, the answer is yes.

As noted above, Friday the all-inclusive BLS labor report is released. Analysts are expecting a 4.7% unemployment rate, a 190k and 185k increase in nonfarm and private sector payrolls respectively, a 0.3% increase in hourly earnings, a 34.4 hour work week and a 62.9% labor participation rate.

Markets Friday were relatively unchanged with the exception of oil which rose about 1.5% as the major oil ports in Libya were seized by militants.

Last night the foreign markets were mixed. London was down 0.34%, Paris down 0.42% and Frankfurt down 0.37%. China was up 0.48%, Japan down 0.46% and Hang Sang up 0.18%.

The Dow should open moderately lower on monetary policy concerns. The 10-year is unchanged at 2.48%.