02/23/17

THERE IS NO GROUP THINK AT THE FED

By: Kent Engelke | Capitol Securities

In my view, the Minutes from the February 1 FOMC meeting were largely a nonevent. The Committee “expressed confidence” that they can raise interest rates gradually while a hike “fairly soon” might be appropriate to avoid the risk of an overheated economy.

The Minutes revealed a tension between participants who are worried about foot dragging at a time when economic reports report solid versus those who want more clarity and still have some concerns about downside risks.

Perhaps the only certainty is today is different than yesterday, the result of the election, an uncertainty that is weighing upon monetary policy. If rising confidence and reduced regulations/tax reform increases monetary velocity, I reiterate the odds of greater than expected growth increases exponentially.

The corollary is if Trump’s proposals do not become policy, further economic atrophy may occur.

Markets were little changed on the release.

What will happen today?

Last night the foreign markets were down. London was down 0.03%, Paris up 0.19% and Frankfurt down 0.19%. China was down 0.30%, Japan down 0.04% and Hang Sang down 0.36%.

The Dow should open flat. The 10-year is up 5/32 to yield 2.40%.

02/22/17

WHAT WILL THE FEBRUARY 1 FOMC MINUTES SUGGEST?

By: Kent Engelke | Capitol Securities

The Minutes from the February 1 FOMC meeting are released today. Will the monetary timetable be changed yet again? Currently the market is suggesting a 38% chance of an interest rate increase in March. Are these odds understated?

Historically, the Fed’s target for short term interest rates is nominally lower than the trend growth in nominal GDP (real GDP plus inflation). Real GDP is about 3.5%, thus suggesting the overnight rate is considerably lower than historical norms.

Recently, the “animal spirits” are stirring because of the potential of less burdensome financial regulations, tax reform and infrastructure spending.

The yield curve between the overnight rate and the 10-year Treasury is around 180 basis points versus the historical average of 106 bps since the 1950s.

The yield curve between the 10 and 30 year Treasury has been holding consistent, believing the Fed will keep long term inflation and inflationary expectations “well contained.”

Is the market correct, defined as benign inflationary pressures even as rates are very accommodative based upon historical norms? What happens to assumptions if monetary velocity accelerates, which it appears that such an acceleration is now occurring as evidenced by nascent increase in M2?

I cannot underestimate the potential risk at hand if the Fed remains too accommodative too long. Excess bank reserves are around $2 trillion versus the historical norm of $1 billion thus suggesting considerable liquidity for inflationary growth.

The national debt is about $20 trillion, yet the debt service requirements — the amount of money needed to service principle and interest — are around 1996 levels when the national debt was 25% of today’s size. If interest rates rose to “historical norms/relationships,” debt service would increase to around $1 trillion versus today’s level of $325 billion or about 30% of the budget.

Wow! How will this impact government spending and interest rates?

The only constants in life are change and reversion to the mean. Confidences levels — same as animal spirits — have increased by amounts not experienced since 1980.

One of the stated goals of the FOMC, via very accommodative monetary policy and QE, is to force all further out on the risk curve, a policy that may have created tomorrow’s crisis.

Will tomorrow’s headlines be of greater than expected growth that has “unanchored” inflationary expectations because of the loss of confidence in the Fed’s ability to provide price stability?

How will this impact stock valuations and bond prices?

It is against this backdrop I would prefer the Fed to err on the side of caution, defined as increasing rates now in an attempt to prevent tomorrow’s future crisis.

As indicated, the odds are only 38%, perhaps the result of seven years of missed Fed policy and horrific fiscal policy and regulations that killed the “animal spirits,” animal spirits that are now awakening.

Commenting upon yesterday’s market action, equities ended higher on global economic optimism and further gains in oil. Treasuries were essentially unchanged.

Last night, the foreign markets were up. London was up 0.12%, Paris up 0.11% and Frankfurt up 0.18%. China was up 0.24%, Japan down 0.01% and Hang Sang up 0.99%.

The Dow should open nominally lower as all are questioning the sustainability of the advance, an advance that was partially the result of the collapse of the cross correlated trades, perhaps the result of the Trump election which may have completely changed the rules. The 10-year is up 3/32 to yield 2.42%.

02/21/17

A POSSIBLE ALTERNATIVE EXPLANATION OF THE CURRENT ADVANCE

By: Kent Engelke | Capitol Securities

Bloomberg writes the Dow has had its largest advance under a new president since LBJ. Many are suggesting the market is priced to perfection and if Trump stumbles, so will the markets. I ask however, based upon many press accounts, Trump is already stumbling badly with the worst approval ratings of any early presidency.

Perhaps there is a different reason, one alluded to Friday and one that is perhaps difficult to quantify or give attribution. Last week the WSJ reported the cross correlated trade that has worked for the last 8-10 years has collapsed. There is attribution for this view, thus this statement should not be viewed as rhetoric or conjecture.

The question that cannot be definitively answered is why it has collapsed. Consensus declaratively stated a Trump victory would be horrific to the markets. I vividly recall futures plunging over 10% late in the evening of November 8th when it was all but assured Clinton lost.

Many times I have commented about the impact of algorithmic and cross correlated trading which represents about 90% of the volume according to the SEC. I also referenced an SEC study that stated 96% of all orders entered were never executed. I further stated there are about 10-12 electronic firms that have replaced the hundreds of “specialist firms,” electronic firms that use the same rules of the hundreds of former specialist firms to maintain market order.

Specialist firms are permitted to take naked short positions to maintain market integrity. Twenty years ago it would be close to impossible for one firm to dominate the market. Today there are 10-12 trading firms, replacing the hundreds of specialist firms, that can take naked short positions, thus suggesting the market “can be prone to market manipulation and imbalances,” quoting a late 2015 SEC study.

Can I suggest the reason for such a strong advance in the face of “accepted turmoil” of the Trump administration is that these naked shorts are now being covered because of economic necessity? Is this the reason why cross correlated trading strategy that has worked almost flawlessly for the past 8-10 years has completely collapsed?

Perhaps. About 14 months ago, I referenced a Federal Reserve report that contained a question that is now asked by regulators about the loan portfolios of the largest money center banks. Does your institution lend money to algorithmic or electronic trading firms?

It was against this backdrop last January that Barclays Bank wrote perhaps one of the greatest risks to the markets is a potential “melt up” because of unreported naked shorts that creates a liquidity crisis for a mega-sized financial firm.

I will readily acknowledge this is very Michael Moorish, perhaps stretching for a reason to explain why “the fail-safe” cross correlated trade has collapsed and to explain the strongest equity advance since LBJ as the Establishment has declared the Administration is operating in total chaos. Uncertainty and chaos normally creates negative market volatility.

Returning back to information that is quantifiable to explain the advance, data that I have already discussed at length, both business and consumer confidence is surging, optimism on earnings calls is high, growth proxies are humming, all of which has already caused a jump in retail sales and rising inflationary expectations.

In my view there is no question the political environment comes up in every discussion and to ignore such is equivalent to ignoring the impact of interest rates to valuation formulas.

What will happen this week?

Last night the foreign markets were mixed. London was down 0.18%, Paris up 0.36% and Frankfurt up 0.62%. China was up 0.41%, Japan up 0.68% and Hang Sang down 0.76%.

The Dow should open nominally higher on economic optimism as the economic activity in the euro area unexpectedly rose to an almost six-year high. The 10-year is down 10/32 to yield 2.46%.

02/15/17

WAS FRB CHAIR YELLEN’S TESTIMONY A NONEVENT?

By: Kent Engelke | Capitol Securities

If one uses fed fund futures, which are a gauge of market sentiment, FRB Chair Yellen’s testimony was almost a nonevent. Before she began testifying, the market was suggesting a 30% probability of a change in monetary policy in March. Now it is 34%.

Yellen said the Fed panel’s outlook for a “moderate pace” of growth is based on continued stimulative monetary policy and a pickup in global activity. She did not mention Trump administration proposals as a key element in the central bank’s forecast.

The Chair stated that consumer spending has continued to rise at a “healthy pace,” supported by gains in household income and wealth, favorable sentiment and low rates. The Fed chief said changes in fiscal and economic policies could affect the outlook, though she declined to speculate how, adding it is “too early to know” what policy changes will be put in place.

The longer dated Treasury market however had a different view of Yellen’s remarks. The 10-year increased in yield to around 2.50%. Last week, it was yielding about 2.32%. Will yields climb to December’s peak of 2.60%? The 30-year Treasury rose to 3.09% versus last week’s level of 2.92%. In December, the 30-year hit a 3.18% yield.

Did yields advance because of Yellen’s remarks suggesting a gradual increase in the overnight rate, which then may suggest the central bank could fall behind the proverbial inflationary curve?

Speaking of which, wholesale prices jumped in January by the most since September 2012, led by higher gasoline costs, thus suggesting inflation is beginning to stir. The 0.6% gain in the PPI followed a 0.2% advance in the prior month. Consensus called for a 0.3% rise.

Equites led by the financials, staged an advance on economic optimism.

Last night the foreign markets were up. London was up 0.49%, Paris up 0.50% and Frankfurt up 0.10%. China was down 0.15%, Japan up 1.03% and Hang Sang up 1.23%.

The Dow should open quietly lower assessing Yellen’s comments. The 10-year is off 3/32 to yield 2.49%.

02/14/17

FINANCIAL STOCKS DOMINATED YESTERDAY

By: Kent Engelke | Capitol Securities

Financial stocks led the markets higher as the reflation trade continues to dominate activity. The averages are now at the highest valuation since 2004 according to Bloomberg, partially the result of economic optimism via the Trump victory. I think it is noteworthy that to date there are no policies implemented much less proposed, only statements of decreased regulation and taxes.

Is the “Mother” of “buy on rumor and sell on fact” trade on hand? What happens if the Trump proposals become stalled, lacking any significant legation, the result of the hyper partisanship in Washington?

Bloomberg writes volume is anemic, thus suggesting this is a convictionless advance, thus suggesting it can be prone to a sharp pull back.

All must remember nothing is ever linear and there will be ebbing and flowing.

Today, FRB Chair Yellen testifies on Capitol Hill. Will her remarks alter the monetary time table? As noted above, the recent advance has been led by the financials predicated upon a strengthening economy and higher interest rates.

How will her remarks be interpreted?

Last night the foreign markets were mixed. London was up 0.07%, Paris up 0.09% and Frankfurt up 0.01%. China was up 0.03%, Japan down 1.13% and Hang Sang down 0.03%.

The Dow should open flat ahead of Yellen’s testimony; a testimony which is expected to be oblique, defined as no one knows the possible implications and ramifications of a Trump presidency which is challenging the established world order of globalism. The 10-year is off 2/32 to yield 2.45%.

02/13/17

DID FITCH RATING AGENCY MAKE A MOMENTOUS STATEMENT?

By: Kent Engelke | Capitol Securities

The ratings agency Fitch stated the Trump administration has increased the risk to international economic conditions and global sovereign debt markets because of potential changes in trade and other polices.

My translation… Fitch is the first ratings agency that is stating the obvious. The world has dramatically changed and yesterday’s rules may no longer apply. Globalism is dead, replaced by economic nationalism that may alter/harm sovereign economies.

I was flattered that some thought I invented the term economic nationalism, but it was an economic philosophy I studied in a geopolitical/socioeconomic class in 1983. It was over 30 years ago when I was first introduced to the concept of globalism/interdependency versus the then waning status quo of economic nationalism.

For simplicity, economic nationalism is defined as “a body of policies that emphasizes domestic control of the economy, labor and capital formation even if it requires the imposition of tariffs and other restrictions on the movement of labor, goods and capitol.”

I cannot emphasize enough the significance of this geopolitical/socioeconomic change, especially as the vast preponderance of investing dollars has gravitated to the mega capitalized momentum growth companies, primarily the result of the globalist/interdependent/multipolar environment.

This huge flow of capital has vastly influenced the averages, an influence amplified by the proliferation of ETFs that by their very basic composition suggests past performance will be indicative of future performance, defined as the big get bigger and the small get smaller and fundamental economic and security analysis is regarded as potentially meaningless.

Has a radical change occurred, but are most fighting this change because trillions may now be regarded as “sunk costs?” In other words, is the Establishment fighting a battle that may not be won given the radical change that has occurred in the demands from the electorate?

I have commented many times Main Street may outperform Wall Street for the first time since around 2004. According to one study by Alpha Research, only 46% of individual stocks outperformed the S & P 500 from 2007-2016, the result I believe is the result of indexing and ETFs. A mere 10 companies have accounted for 26.2% of all wealth in the market since 2007.

Perhaps Fitch has offered more evidence to this view that Main Street will outperform Wall Street as I believe 2007-14 was the apex of the globalist environment.

Commenting about Friday’s market, the averages led by the energy and financial sectors ended higher. Regarding oil, it was reported that OPEC has achieved a record 90% compliance with the production cut accord while demand grew faster than expected. Perhaps more significant, Saudi Arabia reduced production even more than it had committed.

I ask was the kingdom forced into this action because of huge demands for monies… monies that this oil rich sheikdom does not have because of gargantuan transfer payments and fighting a war? Saudi Arabia requires $90 oil to balance its budget. Its sovereign wealth fund has dropped from around $735 billion in 2014 to about $430 billion today. Two years ago, Saudi Arabia forecasted a $700 billion fund.

The Treasury market was relatively quiet as oil rose. There were also further talks about upcoming tax cuts, specifics announced in two to three weeks.

What will happen this week? Several inflation indices are posted, retail sales, numerous housing statistics and manufacturing data points.

Last night the foreign markets were up. London was up 0.13%, Paris up 1.10% and Frankfurt up 0.91%. China was up 0.63%, Japan up 0.41% and Hang Sang up 0.58%.

The Dow should open quietly. The 10-year is off 8/32 to yield 2.44%.

02/12/17

A POSSIBLE REASON WHY THE TECHNOLOGY COMPANIES ABHOR DONALD TRUMP’S TRADE AND IMMIGRATION PROPOSALS

By: Kent Engelke | Capitol Securities
From: 2/9/17

President Trump may soon label China a currency manipulator. While I will skip the obvious notion that all countries manipulate their currencies either overtly (devaluation) or covertly (monetary policy), such a declaration may have wide ranging implications.

China is an export dominated country, defined as its economic wellbeing is dependent upon the financial health of its trading partners. A dated Commerce Department statistic suggested about 45% of Chines production is slated for export, exports dominated to Western Europe, Japan and the US. In other words, China is in a position of inherent weakness.

I reiterate a reason why electronic equipment and many other products are so inexpensive is because of trade policies, permitting exports from regions where labor is extremely cheap as compared to western wages. If the cost of production rises, either margins contract or prices go up. Either scenario may create more uncertainty.

If these increased production costs are unable to be passed onto the consumer, margins will drop, hence stock valuations will also drop.

If these higher costs could be passed on, inflationary pressures may accelerate.

The loudest protesters of Trump’s trade (and immigration) proposals are the technology companies, companies dependent upon cheap labor costs which permit greater access to their products via low prices.

Regarding stock valuation, in my view the technology companies are overvalued, representing about 24% of the capitalization of the S & P 500, eclipsing 2000’s record level which was then viewed as an absolute mania.

What happens if technology margins erode because of higher prices and inflationary pressures accelerate that forces a more hawkish Federal Reserve? Technology companies would get killed from lower than expected future cashflows discounted at a higher risk free rate, amplified by lofty valuations suggesting there is no room for error.

Against this backdrop, it is no wonder the technology companies are ardent detractors of the Trump administration, falling under the guise there is no interest like self-interest.

For the record, I think a trade war between the largest and second largest economies will end poorly… albeit I am in favor of free trade, whatever this may mean, for such will support the common man and Main Street versus a few.

We do live in interesting times where life is indeed stranger than fiction. So much for last year’s mantra that Donald Trump was behaving in such a manner to enable or permit Hillary Clinton to win the presidency for Trump then was also viewed as an elitist entrenched in the Establishment.

Last night the foreign markets were up. London was up 0.30%, Paris up 0.78% and Frankfurt up 0.55%. China was up 0.53%, Japan down 0.53% and Hang Sang up 0.17%.

The Dow should open nominally higher. The 10-year is off 9/32 to yield 2.36%.

02/12/17

WILL ECONOMIC NATIONALISM REPLACE GLOBALISM IN ITS ENTIRETY?

By: Kent Engelke | Capitol Securities
From: 2/8/17

Some are commenting there is a lack of direction in the markets as most are now looking for more details from the Trump Administration on promised tax cuts, reduced regulation and increased infrastructure spending.

For the immediacy, the averages will trade on the perception of policy success. I must write success will be defined differently regarding on what side of the aisle one sits.

To write the obvious, if The Trump Administration delivers 3.5% to 4% growth, a lot of today’s resistance would collapse. Vice versa, if growth collapses, Trump’s vision of economic nationalism would then collapse.

Regardless, yesterday’s globalist agenda is on life support and depending upon the success of Trump’s agenda, and the upcoming elections in both Germany and France, globalism may cease to exist in anything but name.

Wow! It is no wonder the Establishment, defined as anyone who is at the pinnacle of today’s power structure, is fighting so hard. Trillions are at risk in this potential change of global order to economic nationalism.

Yesterday was another quiet day as confusion is starting to grow over the direction of the young Trump administration…growth and regulatory repeal versus trade and immigration.

Last night the foreign markets were up. London was down 0.03%, Paris up 0.40% and Frankfurt up 0.05%. China was up 0.44%, Japan up 0.51% and Hang Sang up 0.66%.

The Dow should open flat. The 10-year is up 8/32 to yield 2.37%.

02/11/17

IS THE ARC OF HISTORY NOTHING BUT AN ILLUSION?

By: Kent Engelke | Capitol Securities
From: 2/7/17

Yesterday was an exceptionally quiet and slow day as a note of caution is spreading through the global markets. Political uncertainty is rising in both France and Germany, two countries that have championed the ECB and globalization.

There is little on the economic calendar and most of the tier IS&P 500 companies have posted results thus all attention will be focused on political development both here and abroad.

Perhaps the only concrete statement to make is if the nationalist parties continue to gain momentum (and offices), especially in Germany and France, globalism will be dead in its entirety.

If this occurs, an idea has failed, the result of a dysfunctional welfare state that forgot about the voter in the hopes of some grandiose and illusive one world order. Wow! This sounds like a line from Star Wars.

Markets hate uncertainty and typically trades lower in such times. But will it be different this time, a phrase that strikes fear in anyone’s heart for it is never different… there are just different people?

About 25 years ago when I first started to opine about global politics, I wrote an extensive report commenting about how the EU and ECB will prosper in good times, but will implode in economic difficulties given the simple premise of there is no interest like self-interest. I wrote in times of economic difficulty, nationalism will trump interdependency and globalism. I also remarked the culture of Western Europe is different than Eastern Europe and north is the opposite of the south, an environment that even the most thought out legislation can not overcome.

Little did I know how prophetic my remarks have become.

Today, The Establishment, defined as anyone who is in power or a position of influence, is fighting the return of nationalism via all means possible, the result of trillions of dollars invested. An idealistic idea that has come to pass because of economic injustices, the result of failed polices that only benefited a select few.

Earlier, I remarked that it is never different, there are just different people. Perhaps “normalcy” is now returning and the Arc of History was nothing other than an illusion.

Enough of the geopolitical and socio economic gobbledygook, as stated above, yesterday was a quiet day. Treasuries however did rally about a ½ point on global political concerns.

Last night the foreign markets were up. London was up 0.64%, Paris up 0.05% and Frankfurt up 0.60%. China was down 0.12%, Japan down 0.35% and Hang Sang down 0.07%.

The Dow should open nominally higher. The 10-year is off 3/32 to yield 2.43%.

02/11/17

AN AMPLIFICATION OF “ANIMAL SPIRITS” VIA THE ROLL BACK OF DODD FRANK

By: Kent Engelke | Capitol Securities
From: 2/6/17

Was President Trump’s Executive Order to roll back Dodd Frank the final catalyst to spur 4% growth? As widely discussed, the economy has failed to grow by 3% per annum for a record 11 consecutive years, vastly impacting the nation’s net worth and income.

I have commented many times that sentiment survey after sentiment survey has indicated that the long arm of government was the greatest threat/hindrance to economic activity. Until two years ago, the greatest fear was economic.

I have also remarked a gazillion times that capital formation is the lifeblood of capitalism and without such growth would be anemic, further stating until monetary velocity accelerates, an acceleration that is/was close to impossible because of intense regulatory burdens, growth would remain lackluster.

There are about $2 trillion in excess bank reserves versus the historical norm of $1 billion. Referencing a dated Chicago Fed report, if monetary velocity accelerated to 50% of its norm, growth would be over 6% and inflation over 10%.

Has Donald Trump released the proverbial “animal spirits,” which could be a distinct possibility given recent sentiment surveys? Will these “animal spirits” be fed by the roll back of Dodd Frank that increases monetary velocity and economic activity (as well as liquidity in the markets)?

I will answer yes. Such a possibility will have a greater impact than Main Street versus Wall Street.

Speaking of which, January’s labor report surprised us on the upside as both non-farm and private sector jobs handsomely exceeded estimates. The all-important labor participation rate rose from 62.7% to 62.9%.

Is this a harbinger of things to come? As noted many times from 1996-2007, 90% of jobs created were from small business, defined as companies with fewer than 400 employees.

This is the economic group President Trump is championing and will be a direct beneficiary via the roll back of Dodd Frank which in turn will permit an increase in monetary velocity and capital formation that enables greater economic growth and job creation.

Last night the foreign markets were mixed. London was down 0.02%, Paris down 0.50% and Frankfurt down 0.72%. China was up 0.54%, Japan up 0.31% and Hang Sang down 0.95%.

The Dow should open quietly lower, assessing the changed socioeconomic and geopolitical landscape. The 10-year is up 12/32 to yield 2.43%.