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

Will history regard Senator Reid’s 2013 ending of the Senate filibuster and the 2014 OPEC decision to flood the world with oil as two of the worst political calculations in recent history? Both have the potential to have an infinite number of unintended consequences as the intermediate future did not materialize as expected.

Commenting about the former, in 2013, the Democratic Party was convinced that it would maintain control of the Senate, win the White House in 2016 and perhaps regain control of the House. Senate Majority Leader Reid pushed through a procedural change that had previously prevented a simple majority ruling for many Presidential appointees. Under the newly passed regulation, only 51 votes were required for approval versus the historical 60.

It appears the Trump Administration will utilize this procedural change to confirm his cabinet appointees and perhaps the nomination to the Supreme Court, the proverbial nuclear option.

For the record, I am in favor of returning the filibuster.

How will the electorate view Democratic insistence of delaying Trump’s picks, a delay which at this juncture is viewed as symptomatic of everything that is wrong in Washington? Will this view change and Trump next be viewed as a proverbial bully by obtaining Senate approval by a change in the approval process that was instigated by the former majority?

As noted yesterday, Trump is a nationalist populist who ardently believes the people, not the government, make better decisions for the country. The majority of the electorate shares this view given the dominance of the Republican party in most levels of government, in some regards the greatest dominance in history.

And then there is OPEC. According to industry reports, there is 88% compliance with the production cuts. Many thought the inverse would occur. Moreover, Saudi Arabia and other cartel and non-cartel members have stated they would reduce production even more if conditions warranted.

I will argue OPEC et.al. does not have any choice other than to reduce production given the lack of infrastructure spending and large demands for monies to fund their entitlement programs. Many OPEC members require oil over $90 barrel to fund their needs.

The above has large implications for the markets. The proverbial animal spirits have been released believing Trump can reduce the power of today’s Administrative State. This releasing of spirits is a major reason for the recent market advance.

Regarding OPEC, will oil double again, the result of stronger demand and lower production as was the case in 1999? As noted many times, the similarities to that era and to today are uncanny. How will such events affect inflationary expectations?

Speaking of which, the Fed ended its two day meeting. As expected, there was no change in monetary policy, but acknowledged rising confidence among consumer and businesses following Trump’s victory.

The Committee reiterated their expectations for moderate economic growth, “some further strengthening” in the labor market and a return to 2% inflation. Policy makers gave little direction on when it might next raise borrowing costs, as officials grapple with the uncertainty created by the new administration. However there was little to alter the prevailing wisdom that there will be at least three increases in 2017.

Markets were relatively unchanged following the Fed’s announcement, thus suggesting it was essentially a non-event.

Last night the foreign markets were mixed. London was up 0.62%, Paris up 0.22% and Frankfurt unchanged. China was closed for a holiday, Japan down 1.22% and Hang Sang down 0.57%.

The Dow should open nominally lower on economic and political concerns. The 10-year is unchanged at 2.47%.



By: Kent Engelke | Capitol Securities
From: 2/10/17

Equities advanced for a myriad of reasons; earnings, potential tax cuts and an advance in crude. Treasuries declined for similar reasons for a tax cut should increase economic activity, activity that will increase the demand for crude, an increasing demand as the markets become “balanced” as according to Goldman. The combination of higher growth and oil may stoke inflationary pressures.

As inferred above, the financials and energy led the advance.

Commenting further about the selloff in the Treasury market, the 30-year auction as met with tepid demand, weak demand perhaps the result of weekly jobless claims falling to a three month low and the four week moving average in now at the lowest point since November 3, 1973.

The Labor Department stated the latest tally marks 101 straight weeks of claims below 300,000, a level considered as a “healthy labor market.” The 161 weeks that ended in April 1970 was the longest streak on record below 300,000, records that commenced in 1967.

Will wage or cost push inflation to begin to accelerate? Such would be welcomed by workers and the economy, but would be the bane of Treasury holders.

President Trump is attempting to boost wages partially by protectionist trade policies and immigration reform.

Today President Trump meets with Japanese Prime Minister Shinzo Abe. Will Trump broach the subject of currency manipulation, an accusation that he made several weeks ago? As I noted yesterday, all countries manipulate their currencies either overtly (devaluations) or covertly (monetary policy). Some believe this is a precursor of a meeting later with Chinese officials.

What will happen today?

Last night the foreign markets were up. London was up 0.30%, Paris down 0.01% and Frankfurt up 0.32%. China was up 0.42%, Japan up 2.49% and Hang Sang up 0.21%.

The Dow should open little changed with Trump’s tax comments in focus. The 10-year is off 6/32 to yield 2.42%.


Stock Splitting Caused Stock Market Crash 1929

By: Wim Grommen

This article explains why the introduction of stock splitting on December 31st, 1927 eventually caused the crash of 1929. The frequent splitting of shares into very large proportions gave a massive boost to the stock market boom, making the stock market crash of 1929 equally violent.

The emergence of a stock market boom

In the development and take-off phases of an industrial revolution many new companies emerge. All these companies go through more or less the same cycle simultaneously. During the second industrial revolution these new companies emerged in the steel, oil, automotive and electrical industries. During the acceleration phase of an industrial revolution many of these businesses tend to be in the acceleration phase of their life cycle, also more or less simultaneously (Figure 1).

Stock Splitting

Figure 1 – Typical course of market development: Introduction, Growth, Flourishing and Decline

There is an enormous increase in expected value for companies in the acceleration phase of their existence. This is the reason shares become so expensive in the acceleration phase of a revolution. There was an enormous increase in price-earnings ratio of shares between 1920 – 1930, the acceleration phase of the second industrial revolution.

Splitting shares fuels price-earnings ratio

Stock splitting refers to the reduction of the nominal value of a share by a certain factor and an increase in the total number of shares by the same factor. Essentially, if the nominal value is reduced by a factor of two the number of shares increase that same factor. This means that the total value of the shares remains the same. A stock split is desirable if the market value of a share has grown too large, rendering it insufficiently marketable. Because there are more potential investors at the lower exchange rate the split causes a positive effect on the value of the share.

The increase in the price-earnings ratio is amplified as well, because many companies decide to split their shares during the acceleration phase of their existence.

Stocks were split for the first time on 31 December 1927, two years before the stock market crash in October 1929. Between 1927 and 1929, the shares of many companies were split into very large proportions (see Table 1). These splits further increased the price-earnings ratio of stocks.

Stock Splitting

Figure 2 – Two industrial revolutions: Shiller PE Ratio (price/income)

Splitting shares also made the Dow Jones Index explode

The Dow Jones Index was first published on May 26, 1896. The index was calculated by dividing the sum of all the shares of 12 companies by 12:

Dow12_May_26_1896 = (S1 + S2 + ………. + S12) / 12

On October 4, 1916, the Dow was expanded to 20 companies; 4 companies were removed and 12 were added.

Dow20_Oct_4_1916 = (S1 + S2 + ………. + S20) / 20

On December 31, 1927, for the first time a number of companies split their shares. With each change in the composition of the Dow Jones and with each share split, the formula to calculate the Dow Jones is adjusted. This happens because the index, the outcome of the two formulas of the two baskets, must stay the same at the moment of change, because there can not be a gap in the graph. At first a weighted average was calculated for the shares that were split on December 31, 1927.

Date Company Split
December 31, 1927 American Can 6 for 1
December 31, 1927 General Electric Company (NYSE:GE) 4 for 1
December 31, 1927 Sears, Roebuck & Company 4 for 1
December 31, 1927 American Car & Foundry 2 for 1
December 31, 1927 American Tobacco 2 for 1
November 5, 1928 Atlantic Refining 4 for 1
December 13, 1928 General Motors Company (NYSE:GM) 2 1/2 for 1
December 13, 1928 International Harvester 4 for 1
January 8, 1929 American Smelting 3 for 1
January 8, 1929 Radio Corporation of America 5 for 1
May 1, 1929 Wright-Aeronautical 2 for 1
May 20, 1929 Union Carbide split 3 for 1
June 25, 1929 Woolworth split 2 1/2 for 1

Table 1 – Stock splits before the stock market crash of 1929

The formula looks like this: (American Can, split 6 to 1 is multiplied by 6, General Electric, split 4 to 1 is multiplied by 4, etc.)

Dow20_dec_31_1927 = (6.AC + 4.GE+ ……….+S20) / 20

On October 1st, 1928, the Dow Jones grows to 30 companies.

Calculating the index had to be simplified at this point because all the calculations were still done by hand. The weighted average for the split shares is removed and the Dow Divisor is introduced. The index is now calculated by dividing the sum of the share values by the Dow Divisor. Because the index for October 1st, 1928, cannot suddenly change, the Dow Divisor is initially set to 16.67. After all, the index graph for the two time periods (before and after the Divisor was introduced) should still look like a single continuous line.

The calculation is now as follows:

Dow30_oct_1_1928 = (S1 + S2+ ……….+S30) / 16.67

In the fall of 1928 and the spring of 1929 (see Table 1) 8 more stock splits occur, causing the Dow Divisor to drop to 10.77.

Dow30_jun_25_1929 = (S1 + S2+ ……….+S30) / 10.77

From October 1st, 1928 onward an increase in value of the 30 shares means the index value almost doubles. From June 25th, 1929 onward it almost triples compared to a similar increase before stock splitting was introduced. Using the old formula the sum of the 30 shares would simply be divided by 30.

Stock Splitting

Figure 3 – Dow Jones Index before and after Black Tuesday

From Stock market crash 1929 to stock market correction 1929

The stock market boom in the period 1920 – 1929 was obviously primarily caused by a huge expected increase in the value of shares belonging to companies in the acceleration phases of their existence. The introduction of share splitting on December 31st 1927 caused an even bigger boom, and the changes in the Dow Jones formula on October 1st 1928 was the icing on the cake.

The stock market crash in October of 1929 would probably have been much less severe if share splitting had not happened (which would leave the Dow Jones formula unchanged). In that case we would not be talking about the stock market crash of 1929 but the stock market correction of 1929.