Indexing the last five years has been a runaway success but has this success created market imbalances?  Many are starting to opine valuations of the mega sized technology issues have created an environment conducive to increased volatility.

Simplistically speaking Tesla is up about 100% in three months and is worth more than GM and Ford combined. Amazon is almost a trillion dollar company that is trading over 70x expected earnings.  Apple is worth $1.3 trillion and is viewed as a growth company.

Because of the manner in which the averages are comprised, the highest dollar companies have the largest influence upon the averages.  Everything is great until it is not.

According to Bloomberg “tech attracted almost $3 dollars for every one dollar of the nearest sector since January 1.”   Wow!

Also according to Bloomberg, oil shares are at the sharpest discount to oil prices in history.  A graph overlaying geopolitical events to that of oil valuations suggests the oil sector is as undervalued as much as sovereign debt is overvalued.  As noted many times negative interest rates are a statistical abnormality occurring only 0.001% of the time.  Yes negative yielding debt has dropped to $11 trillion from $17 trillion in September but such is the ultimate black swan event.

Perhaps the most frightening statistic is that 22% of the shares of the typical S & P 500 company are controlled by passive funds managed by Vanguard, Blackrock and State Street according to Bloomberg.  This is up from 13.5% in 2015.

What happens if volatility on the downside returns?  Will a liquidity crisis occur perhaps threatening the viability of a major non-bank financial as the end user is the customer not a money center bank?  All must remember fear is more powerful than greed.

It is my view this is the fear that is talked about behind the proverbial curtain, validated by last year’s December rout when the Treasury called the largest banks on Christmas Eve Day asking if a liquidity squeeze was at hand.  The answer was no but it was later discovered via Federal Reserve data and examinations credit lines were almost exhausted to several mega sized non-bank financials to meet liquidity demands.

As written in the introductory paragraph indexing is a massive runaway success which today is now “the market.”  It is no longer a strategy; it is the one and only strategy.

Today December’s jobless data is released.  Will the statistics continue to confirm the economy is growing at pace faster than expected?  Will the data again question monetary policy assumptions as the Fed did say everything is data dependent?  If so, will market volatility increase as interest rates are the largest component of valuation formulas?

Analysts are expecting a 160k increase in nonfarm and private sector payrolls, a3.5% unemployment rate, a 0.3% increase in hourly earnings, a 34.4 work week and a 63.2% labor participation rate.

Last night the foreign markets were up.  London was up 0.06%, Paris up 0.03% and Frankfurt up 0.22%.  China was down 0.08%, Japan up 0.47% and Hang Sang up 0.27%.

The Dow should open nominally higher but his could change significantly if the data sharply differs from consensus.  The 10-year is unchanged at 1.85%.


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.