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There is little I can write about yesterday’s market action.  Traders assessed disappointing outlooks from a giant manufacturing and consumer products company.  There are prospects of higher interest rates and oil slumped on predictions of an increase in supply.

The WSJ validated some of my views regarding HFTs stating few understand these trading vehicles; they exacerbate volatility, with little attention focused on leverage, a tenant that can potentially create a systemic event.  Some are speculating this report could usher an investigation and ultimately regulation, two events that I fully support.

The Financial Times wrote 99% of all active managers have been outperformed by passive strategies since 2006.  Wow!  The first ETF was launched in 1993 but it took another 15 years for such to reach the market.

There was about 100 ETFs in 2002, swelling to over 1,000 at the end of 2009.  Today there are more ETFs than listed securities.  To remind all ETFs are passive investment designed to track a specific index.  By definition the big gets bigger and the small get smaller.

In many regards, ETFs break a fundamental regulation inferring that past performance is indicative of future performance.   A dated statistic states 84% of total volume in the “typical stock” is the result of indexing, inferring there is no analysis just buying the shares based upon capitalization.

I can write volumes about this subject but will only opine about two subjects.  First if it was this easy for outperformance all would be gazillionaires.  Secondly such strategies impinge capital formation hence contributes to anemic growth as capital is the lifeblood of capitalism.

Perhaps the proliferation of ETFs and cross collateralized trading  (i.e.  HFTs) is why most of the  bulge bracket firms are bearish, suggesting a 5% to 25% decline is possible in the immediate future.

If everyone owns the largest stocks who is left buy when selling commences, selling perhaps the result of cross collateralized HFTs that few understand much less acknowledge the leverage involved.  Leverage is both the money multiplier and divider, meaning results are accentuated on both the upside and downside.

Last night the foreign markets were down.  London was down 0.98%, Paris down 0.63% and Frankfurt down 0.82%.  China was down 0.50%, Japan up 0.15% and Hang Sang down 1.02%.

The Dow should open moderately lower as Apple disappointed and oil prices fell.  And then there is the election.  According to a Bloomberg poll, Trump has a 2% lead over Clinton in Florida.  The markets hate uncertainty and Donald Trump is the epitome of uncertainty, the anti establishment candidate.  As flawed as Hillary Clinton is, she is a known entity given her 30-years in politics.  The 10-year is off 4/32 to yield 1.78%.

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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.