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Yesterday’s Volatility was Deafening.

Many times I have opined the cheapest execution cost is most often the most expensive decision.  Yesterday’s volatility was deafening.

In my view the almost 1100 point plunge at the open was the result of quantitative/technology based trading.  Markets were in a free fall, a free fall in my view that could have been partially mitigated if “specialists” still ruled the NYSE.

Specialists are gone, the traders who were on the floor of the exchange manually matching buyers and sellers via an auction process.   Yes the specialists were more expensive than today’s technology but yesterday’s early morning plunge was perhaps more expensive than the specialist pay for 10 years.

Marketwatch calculated that $1.8 trillion has been lost since the end of the first quarter with the vast majority of the losses occurring in the past several days.

Speaking of shattering of illusions, there are many examples where ETFs fell considerably more than the securities in the underlying index.  Is this a function that no one really knows how these ETFS are constructed, a concern that I have harbored for many months?

Or were these declines the result of selling in the ETF shares itself were considerably ahead of the selling in the companies’ shares that comprise the index?

But is this not the advantage of ETFs, to have virtual real-time execution as compared to the index not waiting for the execution at the close of the day as is the case with mutual funds?  How much money evaporated because of this discrepancy?

Many times I have commented about the myopicy of the market and the impact of momentum driven trading via ETFs.  Bloomberg noted yesterday momentum trading during the past 12 months outperformed the market by 10 fold, the greatest difference on record.

In fact Bloomberg has named the five biggest momentum stocks as “The Fab Five” further writing these five stocks up to last week comprised all the 12 month gains for the S & P 500.

Has the spine of the momentum issues been broken?  I have compared today’s market to the market of 2000, the last major myopic era.  The major difference between today and yesterday is the vast proliferation of ETFs/technology based trading which vastly increases the velocity of change.

I don’t know if yesterday was the proverbial “capitulation day.” Only history will answer this question.

However I reiterate that there is a possibility of a “market melt up” in the typical stock that was all but forgotten during the last 18-20 months, a melt up that leaves the averages unchanged.

Wishful thinking?  Historically housing and autos leads the recovery.  Both of which are at the strongest levels since 2007 and in my view the gains in these sectors are sustainable.

And then there are jobs.  While I firmly believe the unemployment rate is considerably higher than the posted rate because of an anemic labor participation rate, the economy is creating a significance number of jobs to spur economic sustainability as evidenced by the multi decade low in jobless claims.

Ultimately monies gravitate to areas that offer the greatest potential returns with the least amount of potential risk.  As stated many times, I believe a portion of central bank stimuli has gravitated to the largest capitalized and most liquid names searching for a return, erroneously believing such liquidity would prevent major losses.

I think this illusion was shattered with the collapse of the most owned momentum names.

Will these funds now gravitate to the “real economy,” an economy starved for productivity gains?  If such gravitation occurs, my view of potential “market melt up” in the typical stock is perhaps not that absurd as these issues would profit from such gains in the real economy.

I must remind all that today shall too pass, but the question is when and too where?

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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.