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FRB Chair Yellen suggested yesterday the central bank might delay, but not abandon, planned interest rate increases in response to recent turmoil in financial markets. Yellen also stated the obvious that the turbulence had “significantly” tightened financial conditions by pushing down stock prices, pushing up the dollar and raising most borrowing costs which in turn, if persist “could weigh on the outlook for economic activity and the labor markets.”
Equity markets initially rallied from her remarks but succumbed to late day selling on “renewed fears about the strength of the economy.”
Talk about being in the proverbial rock and a hard place. More dovish monetary policy caused a rally only to sell off because this dovish outlook suggested possible weakness.
Yellen did comment that there has not yet been a sharp drop off in economic growth either in the US or globally despite the big moves in the financial markets.
Last week I discussed the disconnect between Fed policy and the markets, stating that one side is really right and the other really wrong.
Typically when opinions diverge I support the view of the markets. Today however I think the Federal Reserve has the correct outlook.
All data conclusively state trading is now completely dominated by high frequency trading (HFT). Little is known about these algorithms other than there is massive cross correlations between assets groups and 96% of all equity orders entered are never executed thus “creating an environment conducive for possible manipulation” according to the SEC.
Moreover HFTs trade by the same rules as yesterday’s specialist system; a system I thought worked great in providing liquidity. However I believe HFTs are abusing these rules by potentially “naked shorting” or shorting stock that is not borrowed in massive quantities which then drives the stock/bond/commodity considerably lower than economically expected.
Several weeks ago Barclay’s wrote a convincing report that a “failure to deliver” crisis could occur if an unexpected event causes shorts to rapidly cover.
If Janet Yellen is correct in her economic assessment, there can be a strong rally in the typical issue that is underowned and perhaps overly shorted. I have commented many times today is similar to 2002-05 when the typical stock greatly outperformed the indices. As all recall if one did not own the “nifty fifty” in 1999-2000, little money was made.
Today there are not 50 stocks, perhaps only 10. Bloomberg wrote yesterday that 4 stocks (Face Book, Amazon, Netflix and Google) were up 83.2% in 2015. Virtually every other asset category/group was down between 10% and 40%.
I thought 1999-2000 was bifurcated!!
If 2016 is similar to 2002 and if Janet Yellen is correct, the last 16 months was nothing but a really bad dream.
Last night the foreign markets were down. London was down 1.89%, Paris down 3.26% and Frankfurt down 2.10%. China was closed for the New Year, Japan down 2.31% and Hang Sang down 3.85%.
The Dow should open considerably lower. Some are claiming the reason for today’s decline is that the FRB has not publically altered its monetary policy direction. Others claim it is because of fears of increased global weakness. While others claim it is the result of weakness in European banks.
As noted earlier, there is a massive disconnect between the Fed’s thinking and market sentiment, a massive disconnect that is amplifying the impact of cross correlated high frequency trading. Yellen Part II is today. Will she alter her remarks? I think no for the obvious reasons.
The 10-year is up 1 2/32 to yield 1.55%. On January 1 it stood at 2.18%. According to Bloomberg the percentage drop in 10-year yields is the sharpest in history.

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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.