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The Markets Have Become Unduly Influenced by Technology.

Last week has come and gone.  Greece surprised all requesting a delay for Friday’s payment and instead desiring to pay all amounts required this month in one lump payment on June 30.  As widely expected OPEC did not cut production and there was little public display of acrimony between rival members such as Saudi Arabia and Iran. Regarding jobs, non-farm and private sector payrolls were considerably higher than expected; there was acceleration in labor costs and an increase in the Labor Participation Rate (LPR).

Commenting about the jobs data, hourly earnings rose the most since August 2013 and the number of workers entering the labor force caused the unemployment rate to creep up to 5.5% and the LPR to rise 0.1%.

Treasuries sold off on the data and Fed Funds futures, which are a proxy of market sentiment, are now suggesting a 90% chance that the overnight rate will be increased in September.

The pivotal question at hand is how much will these higher yields impact valuations?  Many have remarked equity index valuations are “stretched” and any increase in rates will negatively impact prices given that interest rates are a primary component of most valuation models.

I will add an additional caveat to the above concerns.  Most will agree the markets have become unduly influenced by technology where it appears everything is crossed correlated that causes indiscriminate selling often times in issues that are already undervalued and no material news events have been announced.

I can for see an environment where the indices trade lower but the typical stock outperforms, the inverse of the last 12-16 months, as I think the dominant trading strategy of last 24 months has run its course.  Such an environment is conducive for active management but may lower confidence even more in the equity markets given the proliferation of mindless ETFs and indexing, a proliferation that has created many products where few know or understand their composition.

In some regards, today’s ETFs resemble CMOs and CDOs of 2007-08 in both the perception of lack of risk and diversification.

Some might comment there is no basis for the above concern, but I write such a concern has been voiced by several regulatory entities.

Regarding oil, oil was volatile Friday after the OPEC meeting closing up about $1 for the day.  “Some” had commented that the market was relieved that OPEC did not increase production, a concern that I was not aware.

Why the advance?  I will suggest it was the stronger than expected jobs data which will may create greater potential demand for crude.

Incidentally, for the week oil ended nominally lower, the first down week I twelve.  Oil had rallied a record eleven consecutive weeks.

What will happen this week? Retail sales, various inflation statistics and sentiment surveys are released.

Last night the foreign markets were down.  London was down 0.71%, Paris down 0.49% and Frankfurt down 0.75%.  Japan was down 0.02% and Hang Sang UP 0.21%.

The Dow should open nominally lower.  Emerging markets are heading for the longest losing streak in 24 years, European equities down because of Greece, and the proverbial monetary policy concerns in the US.   In my view, equities have priced in many positives and are stumbling searching for a catalyst to go higher or lower. The 10-year is up 3/32 to yield 2.40%.

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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.