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US Markets are Facing Considerable Headwinds From the Turmoil in Greece and China

US markets are facing considerable head winds from the turmoil in Greece and China.  I would like to first discuss China.

As widely reported the Chinese market has plummeted over 30% in about 3 weeks.  Trading has been halted in 70% of listed companies’ shares.  Major shareholders and insiders are now prohibited from selling holdings for six months.  In other words, there is no liquidity and where there is liquidity, the selling pressure is exponential.

I can argue the “issue” in China commenced in November 2014 when international funds gained unprecedented access to the Shanghai market through an exchange link with Hong Kong.  A single foreign investor can own as much as 10% of a company’s issued shares.

I believe an unprecedented amount of western momentum monies flocked to the Shanghai index, bidding that bourse up about 125% in seven months. This money is now exiting the Chinese market at a frightening pace.

In my view, there are two initial major take aways.  First when selling commences, who is left to buy if everyone owns the securities?  Second, I think China has been sent its open market reform initiatives back 20 years.  Western investors demand liquidity and liquidity evaporated because of China’s misguided and heavy handed attempts to stabilize markets.

There is ample commentary about how the potential economic fallout from the Chinese market implosion. I would like to make two comments.

First, China is an export driven economy, desperately trying to increase consumerism.  Depending upon the source, the consumer is 25%-30% of the Chinese economy versus 70% in the US.  Exports/infrastructure building comprises about 70%-75% of China’s GDP.  In other words, the wealth effect may not be a dominating factor.

The second comment I would like to make is the impact of momentum driving monies and the distortions the result of technology driven and ETF/capitalization based investing, a view shared by the US Treasury and Federal Reserve.

In fact both regulatory entities have remarked about the lack of liquidly in the US Treasury market which is regarded as the most liquid market in the entire known universe.

I hope China is not a harbinger of things to come where the term “velocity of change” takes upon a new meaning.

Regarding Greece, most believe a resolution will be at hand by Sunday.  The question is what will be the resolution and how will such be interpreted.  Yesterday’s release of the Fed Minutes directly mentioned the potential negative impact of Greece.

Returning back to yesterday’s market, as widely disseminated, trading on the NYSE was halted for about 3 hours.  Other than increase the banter about Chinese cybersecurity conspiracy theories, the halt had no impact upon liquidity given the redundancy of trading systems. Orders were rerouted to BATS, ARC, NASDAQ, etc.  According to Bloomberg no one exchange handles more than 16% of volume.

Fourteen years ago, the NYSE handled the vast majority of NYSE listed trades.  When Wall Street’s infrastructure was damaged on 9/11, the markets were closed for four days.

What will happen today?  Alcoa kicked off second quarter earnings season, results that missed expectations but were regarded as “solid” as revenues exceeded estimates.

Last night the foreign markets were up.  London was up 1.30%, Paris up 2.45% and Frankfurt up 2.24%.  Japan was up 0.60% and Hang Sang up 3.73%.

The Dow should open significantly higher as China advanced about 6% on government mandates that insiders and large shareholders are prohibited from selling shares for 6 months. Moreover there is increasing optimism that a Greek debt crisis will not spread. The 10-year is off 18/32 to yield 2.26%.

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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.