By: Kent Engelke | Capitol Securities

Markets were slammed again, the result of stronger than expected growth that is causing higher interest rates, amplified by algorithmic trading. Selling was robust following a “tepid” 30-year Treasury auction. To me, it is incredibly obvious the markets were leveraged to low rates forever, a concern that I had voiced many times.

Selling accelerated mid/late afternoon and Barclay’s Bank wrote the sudden selling may be the result of the deleveraging among volatility targeting funds that is to unleash $225 billion of equity sales in the coming days. Selling commenced when several volatility funds reopened following several days of a trading halt.

In my view what is frightening, according to Barclay’s, there is approximately $500 billion tied to funds that target a given level of volatility, two thirds of which are traded by algorithms.

Ouch!!

In my view, the major difference between this selloff and 2008’s is today’s decline is the result of economic strength not weakness. Historically, averages initially selloff as the Fed tightens monetary policy, but a major difference of today versus years past is that the markets were “programmed” for low rates and anemic growth forever and this was the path of the last 10 years.

The question now at hand is whether or not the markets fall into full panic mode, the result of rising rates and the proliferation of algorithmic traders utilizing similar trading models.

Changing topics, but pertinent to market activity, will growth exceed even the most optimistic assumptions? According to the Dallas Fed, capital spending outlays during the last six months is at the greatest level since records began in 2001. It is largely expected capital spending will continue to accelerate because of the change in the tax code which permits immediate expensing of capital spending goods. Moreover, tax reform lowered the tax rate from 35% to 21%.

Economics 101 states capital spending drives up growth, productivity and wages. I ask rhetorically, will the economy once again experience that once in a generation jump in productivity that former Fed Chair Greenspan stated occurred in the late 1990s when growth exceeded 4% for four years?

Speaking of strength, yesterday’s jobless claims were lower than anticipated and the four-week moving average is at the lowest since March 1973. Wow!

Against this backdrop, sovereign debt yields are beginning to globally rise. The yields on the US Treasuries are climbing. The German 10-year is at its highest level since September 2015. The BOE is discussing rate hikes because of greater than anticipated global growth.

Yesterday, I received considerable feedback that the markets now resemble a casino given the massive technology induced swings in volatility. I think this point cannot be debated given 500 point moves occur within 10 minutes, activity in my view that can only be accomplished via technology utilizing derivatives and futures.

Recent data suggests 10% of market volume is the result of traditional buying and selling by people, 40% is indexing and 50% is done algorithmically utilizing complex models shorting one sector, going long in another via derivatives and futures with a holding period at times measured in seconds.

The educated ones state such trading adds liquidity to the markets. As with all “can’t fail” strategies, it works until it does not, especially when transparency is entirely lacking and leverage in both the absolute (borrowed monies) and relative (controlling of a large position through a synthetic vehicle representing fractional ownership) is at record levels. In this environment, liquidity becomes nonexistent.

What will happen today?

Last night the foreign markets were down. London was down 0.60%, Paris was down 1.17% and Frankfurt was down 1.31%. China was down 3.19%, Japan was down 2.32% and Hang Sang was down 3.10%.

The Dow should open nominally higher, but obviously this could change radically. Bloomberg writes the S & P 500 is close to testing the 200 day moving average as well as the uptrend line off the 2016 lows. The 10-year is off 2/32 to yield 2.84%.