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Stocks led by energy rallied yesterday on the belief that monetary policy will remain unchanged until March 2016, perhaps under the simplistic guise of “bad is good.” September’s ISM non-manufacturing data disappointed albeit the data is consistent with GDP growth of 3.5%. Even allowing for the weaker ISM manufacturing index, a weighted average of the two indices points to GDP growth of between 2.5% and 3.0%.
Perhaps the most surprising aspect of the ISM non-manufacturing index is the employment sub index actually strengthened to a usually strong 58.3 from August’s 56.0 reading. Such a level is consistent with monthly gains in private payrolls of more than 300,000, which is considerably higher than the 126,000 average gain of the last two months.
Wow! This observation is the inverse of the weakening narrative!
Equity valuations are dictated by corporate cashflows discounted by some interest rate. As noted, consensus now thinks monetary policy will remain unchanged until March 2016. Even though there is little optimism in the upcoming profit season that commences on Thursday, a Fed index tracking profits at US companies, which tends to move lockstep with income at S & P 500 companies, posted its biggest quarterly advance since 2012’s second quarter.
Is the advance sustainable? Interest rates are now expected to remain unchanged for the next 5-6 months. Expectations are low for a strong earning season, a season that may surprise on the upside based upon data from the Fed. Pessimism is great. The economic data is not suggesting a recession is in the foreseeable future.
Against this backdrop I would place the odds of a sustainable advance at 65% but all must remember that yesterday’s gains were also skewed by HFT, trading that does not necessarily reflect prevailing economic conditions.
Speaking of such, as noted the gains were led by energy/commodities as the dollar traded lower. At this juncture there is little geopolitical premium embedded in energy. Is this about to change?
Last week the President further reinforced the view the US is no longer the global policeman in his UN statement “a single country cannot solve the world’s problems alone. The answers must come from a collected body.”
In the absence of leadership, a vacuum develops until another dominant force arises. Will yesterday’s greatest laggards become the market leaders because the lack of global leadership? One day does not make a trend but I will argue any sustainable gains will be the result of monies gravitating into the lessor owned issues.
Last night the foreign markets were mixed. London was down 0.16%, Paris up 0.24% and Frankfurt up 0.31%. China was up 0.48% Japan up 1.0% and Hang Seng down 0.10%
The Dow should open nominally lower as many assess the landscape, pondering has the averages gone too far too fast, perhaps the result of HFT on the buy side. The markets are on the upper end of the recent trading range. The 10-year is up 5/32 to yield 2.03%.

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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.