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According to FISUM, Vanguard, Blackrock and State Street are the largest holders of 88% of S & P 500 companies. Wow! The potential influence that these companies can exert upon markets and corporations is incredible.

Several times I have opined the next financial crisis could be focused in a non-bank financial, suggesting that an ETF sponsor or asset manager can be the cause given the untestedness of many products that were not in existence 5-7 years ago.

About a month ago there were considerable headlines from the announcement Treasury Secretary Mnuchin asked the largest banks as to whether or not they were experiencing liquidity issues. All said no. It is my understanding the Treasury does not directly regulate non-bank financials in the same manner as they regulate banks.

I had hypothesized a major reason for Treasury’s question was whether or not any electronic based trading firms were experiencing any issues since these firms borrow from the largest banks.

It is generally accepted firms such as Vanguard, BlackRock, et.al. are the primary catalysts for the collapse of money management fees, the impetus of the managed money phenomenon and the rise of passive/index investing where cost of execution and capitalization are two domineering variables.

I believe security lending is a major profit center for BlackRock et.al. given the interest rate and other charges to perform this service. It is my understanding; an issue at hand is that equity trading is now dominated by 12-15 trading firms that follow similar regulations of yesteryear when there were over 500 decentralized specialist firms.

In my view the risk spread over 500 firms is easier to manage than risk spread over 12-15 firms. It may be cheaper to have only 12-15 firms but often times the cheapest execution is the most costly decision.

Speaking of costly execution, markets were significantly lower yesterday as the S & P 500 tested its 50 day moving average, a key momentum metric that it breached late last week for the first time since early December.

Even though volume was only average, Bloomberg writes yesterday’s tumble was ugly as 95% of S & P 500 shares fell, the worst drop, breadth wise since December 24. Moreover 89% of volume is in declining stocks which rivals the 88.4% seen on December 24.

The catalyst for the decline was trade and economic fears, trade fears that rose further late in the day on headlines the US turned down an offer of preparatory discussions.

What will happen today? Fourth quarter earnings season is accelerating and all are extrapolating forward looking statements. First quarter results are now expected to rise by 1.7%, down from 5.9% at the end of November. Second quarter results are expected to increase by 3.6% versus a 6.8% estimate two months ago, a decline led by the outlook for technology companies.

Last night the foreign markets were mixed. London was down 0.32%, Paris up 0.37% and Frankfurt up 0.24%. China was up 0.05%, Japan down 01.4% and Hang Sang up 0.01%.

The Dow should open nominally higher after stronger than expected earrings for several companies including IBM which is lifting the shares off of a 10 year low. There is some emerging optimism about reopening the government shortly and for trade. The 10-year is off 7/32 to yield 2.77%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.