Some believe the “illusion” of liquidity could be shattered in the intermediate future as more on Wall Street are adopting the view that technology based trading will be the bane of the markets, a view that I have expressed many times.

Bloomberg writes “algorithmic trading strategies and other quantitative traders have caused exacerbated moves on both the up and downside in equity market as AUM continues to flow out of actively managed equity funds and there are less participants to bring markets back to equilibrium.”

Bloomberg referenced a previously discussed JP Morgan report stating equity liquidity in December was one third of previous selloffs, blaming this lack of liquidity from the large shift away from human to electronic market makers that disappear in times of volatility. Bloomberg went as far as writing “algorithmic traders are a destabilizing force with many believing that such will provide nonexistent liquidity.”

The newswire wrote the scale of this shift in market structure is highlighted by a previously discussed JP Morgan study stating “exchange traded funds and algos dominate all but 10% of US stock trading.”

Bloomberg concludes “the illusion of liquidity dampens volatility but when that illusion is broken, volatility will be higher than it otherwise would have been which then could usher in changes to ensure that such does not occur again.”

Earnings season commences tomorrow. Some are concerned that the market could be facing a rude reawakening as both revenues and profits disappoint on companies that have a lot of dependence on overseas sales. A major culprit is the strong dollar and weakening consumer demand from abroad. Bloomberg writes “firms with highest share of overseas revenues are about to report two straight quarters of losses, the first such occurrence in over 10 years.”

The issue at hand, according to Goldman, a basket of companies with highest share of international revenue has surged 23% this year, almost 15% more than companies with the highest domestic exposure. Goldman states the current environment is a “conundrum,” an environment “in which shares in companies with high amount of overseas sales must come down.”

The pivotal question at hand is whether or not profit disappointments be the catalyst for a selloff that confirms the illiquidity thesis? In this case I hope my views or the emerging view on Wall Street are wrong.

Many times I have opined “it is not one does but rather why one does it,” a mantra that has all but been lost on Wall Street where style is completely dominating substance. Most will agree macroeconomic, geopolitical and security research is virtually nonexistent on Wall Street, where 90% of investing decisions are made by a computer program that emphasizes capitalization.

Is this about to change? Only history can answer that question.

Last night the foreign markets were mixed. London was up 0.13%, Paris up 0.78% and Frankfurt up 0.37%. China was down 1.60%, Japan up 0.11% and Hang Sang down 0.93%.

The Dow should open flat. The 10-year is off 4/32 to yield 2.49%.

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. 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. The material provided in Daily Market Commentaries or on this website should be used for informational purposes only and in no way should be relied upon for financial advice. Please be sure to consult your own financial advisor when making decisions regarding your financial management. Members of FINRA and SIPC, Capitol Securities Management is a privately owned full-service retail brokerage and investment advisory firm headquartered in Richmond, Virginia. For nearly 30 years, we have been serving the needs of our investors. Today, more than 200 Capitol Securities Management investment professionals and support staff serve approximately 18,000 customer accounts from Southern Florida to the New England coast.