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The Market is Riddled with Contradictions.

Will this week be of significance?  Wednesday is a Fed meeting and Friday is the initial release of second quarter GDP, statistics that I am certain the Committee will have before its meeting.

In my view the market is riddled with contradictions.  Housing prices are at a record.  Historically rising home prices positively correlate to strong economic activity given that most people measure their net worth by the value of their home versus stock account, hence offering confidence.  And then there are jobless claims which continually improve are around 40 year lows.

Conversely, commodities have been crushed, trading around 13 year lows.  Moreover the Treasury has rallied sending yields to four month lows, partially predicated by the belief of slowing global growth.

Many times I have written about the lack of monetary velocity and the gargantuan levels of excess bank reserves.  The WSJ wrote Friday that banks maintain an “extraordinary $29 of reserves for every dollar they are required to hold.”  Furthermore the Journal reported in the first quarter of 2015 banks actually deposited more in the Fed ($65.1 billion) than they lent ($52.5 billion).

Can we remotely suggest monetary policy of the last seven years has not had the intended effect—increase lending by banks?

I believe there are many reasons for this hesitancy, primary among them is intense government interference and regulation, but at some juncture these funds will be utilized in a more efficient manner.  But the question is when??  I am certain the Committee is asking a similar question.

I can make a rhetorical argument that some of these excess reserves have gravitated into the financial markets, a gravitation that is skewing activity to the largest and most liquid/capitalized companies.

Speaking of which, Friday was an extension of days’ past…aggressively sell the most liquid names that missed profit expectations (i.e.  COF which was down 13%) and dumbfoundly buy the issues that exceeded expectations (i.e.  AMZN which was up 11%).

I have not experienced such irrational volatility since 2000.  It appears all are chasing momentum, a questionable strategy that is based upon one variable…the current direction will continue infinitely and to heck with valuations.

If history is to serve as guide, momentum investing ends badly.  The question at hand is what will be the catalyst for such a change?

Could it be a change in monetary policy that reduces bank’s excess reserves via a more productive use of funds?  Maybe.

Could it be valuations as certain sectors of the markets are exceedingly inexpensive on a historical basis?  Maybe.

Could it be the lack of ownership of most names hence suggesting any type of buying creating a possible market “meltup” in the typical company?  Perhaps.

I don’t what it will be or when it will occur.  However again utilizing history, a transition will come at some juncture under simple guise that change is always the only constant.

Commenting upon Friday’s activity, led by commodity companies and biotechs, stocks ended considerably lower.  It was reported that for the first time since the 2006 inception of this data point, hedge funds have a net short position in gold.

The S & P 500 is now down four out of the last five weeks partially the result of earnings that have been hampered by the dollar and overseas weakness.

Last night the foreign markets were down.  London was down 0.51%, Paris down 1.74% and Frankfurt down 1.66%.  Japan was down 0.95% and Hang Sang down 3.09%.

The Dow should open moderately lower as China sold off the most in over 8 years. The dollar is lower on speculation the Fed will delay its time table in raising interest rates. The 10-year is up 6/32 to yield 2.24%.

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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.