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Markets Ended Quietly, but Moderately Lower on Friday.

Markets ended quietly but moderately lower on Friday.  First quarter GDP was revised to -0.7% versus the previous estimate of 0.2%.  Analysts had thought growth would be revised to -0.9%.

Why the missed revision?  Inventories did not increase as great as expected and business investment was stronger than initially reported.  Net exports were weaker than thought as exports were down 7.8% and imports up 5.8%, the result of the dollar and the commanding economic strength of the US as compared to our trading partners.

Consumer spending was essentially unchanged versus the initial estimate…up 1.8%.

One can view the data either positively or negatively given one’s preconceived bias.  On the negative side, the strong dollar is hurting the economy hence potential profits (and valuations) of the mega capitalized multinationals.  On the positive side, inventories are smaller than expected and business investment is not as poor as first thought.

Last week I was commenting about the large influence of ETFs and indexing.  Many do not know the true composition of these ETFs believing that such funds are an inexpensive manner to diversify and reduce risk.   Are these beliefs accurate or has the massive proliferation of ETFs/indexers taken a similar route of CDOs and CMOs of seven/eight years ago?

CDOs and CMOs were initially great products to diversify risk in the mortgage market.  However by the mid 2005 the products became so complex, there were maybe two people who understood how the products were comprised, individuals who had poor communication skills but were incredibly talented mathematicians.

It is my firsthand experience, when someone does not understand a product and “issues” arise, bids quickly disappear, an environment amplified by regulatory pressure where all are required to know the product’s complexities before recommending purchase.

Are ETFs/indexing at this point?  A major hot button for FINRA is leveraged ETFs and I can argue these concerns will gravitate to many other ETFs.

As noted above, the strong dollar was a major reason as to why net exports were considerably lower than expected.   If this trend continues, will the profits of the mega cap multinationals which are a major composition of most ETFs/index funds, disappoint and triggers selling, selling that is exacerbated given few really know how these ETFs are comprised?

After meeting with Lehman Brothers eight or nine years ago I made a similar comment about Lehman’s structured CDOs and CMOs, comments that were dismissed by the person that was covering me from Lehman.

This week can be one of significance.  On Friday there is the OPEC meeting and the BLS Labor Report.  Commenting on the former, consensus expects no change in output.  Regarding jobs, the labor participation rate (LPR) is rising to greater significance given almost the near unanimity the falling unemployment rate is largely a function of workers leaving the workforce.  Firings have abated but hiring is only moderate based upon past expansions.

Commenting about oil, crude climbed over 4% Friday capping a record 11thconsecutive weekly gain after the EPA proposed cutting quotas for use of renewable fuels in gasoline.  Moreover the rig count fell to the lowest level since August 2010.  Inventories have declined for four consecutive weeks.

The question at hand is why are oil stocks performing badly?  The answer…higher prices will increase supplies which then will hurt prices. As noted, no change in OPEC production is expected.

And then there is Greece.

Last night the foreign markets were mixed.  London was down 0.17%, Paris down 0.14% and Frankfurt down 0.13%.  Japan was up 0.03% and Hang Sang up 0.63%.

The Dow should open flat as all attempt to discern direction.  Bloomberg writes that during May, equities moved in the narrowest trading range in eight months ont eh weakest volume of the year.  The 10-year is off 2/32 to yield 2.12%.

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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.