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The Four Major Possible Trends that I Have Focused on During the Past Nine Months May be Coming to Fruition.

The four major possible trends that I have focused on during the past nine months may be coming to fruition.  I will address the four in no particular order.

First is oil.  I have been an oil bull for four simplistic reasons.  I have argued there will be a cut in production from non-OPEC nations.  The IEA announced Friday 2016 oil production outside of OPEC is expected to decline by the greatest amount since the 1992 implosion of the Soviet Union.  The IEA also predicts oil demand this year will be the greatest since 2010.

I have also argued the drop in oil prices will not only threaten the existence of companies but countries.  Fifty percent of OPEC countries are on the verge of financial collapse, a collapse that could potentially spur greater social unrest.

I have also stated odds of supply disruptions are rising exponentially given civil unrest.  I think it is of great significance Friday the Pentagon stated its goals in the Middle East are far from being achieved and American interests/influence has waned by an amount greater than reported by the Administration.

My final argument for higher oil prices is stronger than expected growth in the US, Japan and Western Europe that increases demand.  I will comment about domestic growth component later, especially as it relates to this week’s FOMC meeting.

The next major trend I would like to discuss is China, stating many times the impact of a slowdown in Chinese growth is not the calamity some are suggesting.  Capitol Economics reports if Chinese growth increases by 6%, it would contribute one percentage point to global growth, which is almost the same as its contribution in 2005 when China’s economy expanded at 11%.  Why…greater growth rates in the US, Europe and Japan.

Capitol Economics further states if Chinese growth is only 2% from 2016-2020 versus the consensus view of 6%, with everything held equal global growth rates would fall by 0.8% to around 3.0% vs. the 3.8% estimated growth rate.

I have compared the narrative surrounding China to that of Japan 25 years ago.  Japan was growing by 4.4% in the 1980’s and many pundits were then predicting Japan will overtake the US in less than a decade.  Japan imploded and many made dire predictions as it growth rate collapsed to 1.5% in the 1990s, very few of which came to fruition.

Next I would like to comment on potential stock performance and volatility.  Many times I have discussed the myopicy of the market, a myopicy dominated by HTFs, ETFs and momentum driven trading that ignored all but a handful of the largest capitalized issues. 

I think data from a Bloomberg newswire report is significant.  According to Bloomberg, the volatility in the S & P 500 is exponentially higher as compared to the Russell 2000 since August 20 when the current swoon began.   This trend actually commenced about seven months ago when the gap between the S & P 500 VIX and the Russell 2000 began to narrow.

Since August 24 and as measured by the VIX, the VIX for the S & P 500 closed higher on six different occasions than the close of the VIX for the Russell 2000.  Such a closing has only occurred twice in the prior 11 years according to Bloomberg.

Moreover the Russell 2000 is greatly outperforming the S & P 500 since August 20.

I have opined there is a 50% probability of a possible market melt up in the typical stock at the expense of the few over owned mega capitalized issues that dominate the indices, the result of lack of ownership and lack of overseas exposure/dollar strength that could jeopardize earnings. All must remember that according to S & P, 48 % of the S & P 500’s revenues come from trade versus 15% for the Russell 2000.

Moreover, historically stronger domestic growth supports the typical stock versus the mega capitalized issues.

This is the segue way to the forth major potential trend, especially as it relates to this week’s FOMC meeting.

Typically there are five major components that lead an economic recovery, all of which but one are exceedingly positive.  Auto and home sales are at the strongest levels since 2006-07 with little indications of slowing.  Job growth is occurring with some data suggesting the labor market is the strongest since the mid 1970s. 

Bank lending is rising, rising at the greatest level in at least 50 years.  According to Fed data, bank lending is increasing at an average of 7.8% per month.  The average increase from 1960-2014 was 5.5%.  From 2005-2014 bank loans rose by 4.9% per annum.

And then there is confidence.  Confidence levels which were robust fell in September to the lowest level in a year, declining the most in one month since the end of 2012, the result of the market swoon. Confidence only fell back to its long term average. Will confidence stabilize if the market stabilizes?  I think it is noteworthy some of the components of this confidence survey is suggesting a 3.0% increase in consumption.

Will growth be stronger than expected?  The narrative about this week’s FOMC meeting is incredibly intense, an intensity matched only by some type of pending biblical natural disaster.  I am certain next week the endless bloviating and possible consequences of any announcement will reach epic proportions.

However, as market participants we must try to read through the noise.  In every financial document the disclaimer “past performance is not indicative of future performance” is written.  

But I will ask what do we rely upon for market benchmarks if history is ignored?  Momentum or the prevailing idea that a stock will continue to rise or fall based upon its current direction and to hell with macroeconomic fundamentals?

As stated earlier, a case can be made this momentum trading strategy is in the early days of ending, perhaps the result that the trade is so “crowded.”

I am a firm believer in the comment “it is not what you do but rather why you do it.”  The past 12 months have been incredibly difficult, a difficulty more pronounced for those not involved in components of the momentum trade.

Even though 4-6 weeks is too short declare the trend has changed, there are the proverbial green shoots of hope.

Last night the foreign markets were mixed. London was up 0.13%,  Paris down 0.04%  and Frankfurt up 0.10%.  Japan was down 1.63% and Hang Sang up 0.27%.

The Dow should open nominally higher ahead of the Fed meeting which most believe there will be no change in monetary policy, partially the result of Chinese data that disappointed.   The 10-year is up 5/32 ot yield 2.17%.

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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.