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Monies Ultimately Gravitate to Sectors that Offer the Greatest Potential Reward and Least Potential Risk.

I have commented many times the markets have been co-opted by technology.  An inordinate amount of market volatility is the result of indexing and ETFs, a view that is also partially shared by Fed Reserve Chairwoman Yellen.

Yesterday the Wall Street Journal reported that in a typical trading session liquidity is challenged mid-day given the absence of ETFs and index buying that is now dominating trading.  The WSJ cited a Credit Suisse report stating more than one in six trades in the S & P 500 companies traded between 3:30 and 4:00.  This is about 17.8% of total volume as compared to 13% in 2007.

The Journal further reported about 6% of total volume occurs in the final minutes, rising each year since 2010.

For shares of smaller companies, Credit Suisse reports 19.3% of trades were reported in the final 30 minutes up from 14% in 2007.

Several weeks ago I referenced a Goldman Sachs’ report stating approximately 83% of the volume in the smaller capitalized issues was the result of indexing, inferring there is little interest in these entities outside of indexing/ETFs.

I also referenced a Fundstrat Global Advisor report citing the dispersion or variance of returns for individual stocks is at the widest margin since 1979.

In years past I have opined panic selling typically occurs in the morning and informed buying takes place at the close.

What is the point of the above diatribe?  Yesterday I commented equities “feel” as though there will be yet another transition as to what dominates trading.  Onceeveryone is utilizing a similar trading strategy, change typically occurs.

Several years ago I opined about the largest banks not having any trading losses for almost 150 consecutive trading days, stating that if it were only this easy.  Rhetorically speaking, since this incredible streak ended, the largest banks are regularly producing trading shortfalls.

While I will not write the largest capitalized issues are in a bubble, I will agree with many including FRB Chair Yellen that prices are “fully valued” based upon current interest rates and cashflows.

Will the largest capitalized issues/indices underperform the result of ETF/indexing liquidations that feeds upon itself?

If so where will these funds gravitate?  I am a firm believer monies ultimately gravitate to sectors that offer the greatest potential reward and least potential risk.  As noted above, accorind to Fundstrat the variance or dispersion amongst stocks is the widest since 1979.  Under this premise I would argue the smaller and forgotten names will be the beneficiary of potential ETF liquidation, liquidations that might occur during the last 30 minutes of trading when rebalancing occurs.

What will happen today?  Will the revision to GDP impact trading?  Consensus is expecting a downward revision to -0.9% from 0.2%.

Commenting on yesterday trading, oil rallied at the close ending nominally higher even as the dollar advanced.  Equities were quietly lower and Treasuries essentially unchanged.

Last night the foreign markets were mixed. London was up 0.30%, Paris down 0.50% and Frankfurt down 0.47%.  Japan was up 0.06% and Hang Sang down 0.11%.

The Dow should open quietly lower.  Reflecting upon the month, May could be a transition month given concerns about the US economy, Greece, Middle East and interest rates.  The intermarket volatility is not reflected in the indices, perhaps the result of ETFs/indexing. The 10-year is up 2/32 toyield 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.