Analysis, Perspective, Trading Strategy
Risk May be High, but Don’t Fight the Momentum Yet
By Joe Duarte on July 8, 2018
late Marty Zweig often said: “Don’t fight the Fed, and don’t fight the
market’s momentum.” And this market is offering a perfect opportunity to heed
those famous words of wisdom.
I’m not blind. And this market with its volatility and its robotic
trading signature surely gives me the willies. Yet, with the upside
momentum displaying a full reversal of the terrible pace and direction
of the Q4 massacre, the opportunity to make money is too good to pass
up for now.
Accordingly, it’s hard to be bearish when you note the new high on
the New York Stock Exchange Advance Decline line this past week, which
signals rising momentum to the up side. Thus, for now, the path of
least resistance, albeit with some scary bumps in between, seems to
Here are the big picture bullets to consider:
- This is the third year of the Presidential Cycle, a traditionally
bullish year for stocks
- The odds of a global central bank easing cycle are rising
- This is a momentum market fueled by expectations of lower global
- Headline risks persists: Think U.S.-China trade war, slowing economic
- Technology (XLK) and Emerging Markets (EWZ, EWA,EWM,EWS) remain
- The rally is broadening: Think Biotech (BIB), Banks (XLF), and
Big Pharma (XLV)
- Volatility is here to stay
Hopes of Lower Interest Rates Fuel Stock Rally
First and foremost on the bulls’ list of reasons for higher stock
prices are the central banks, which are clearly recognizing the global
economic slowing and are hoping to avert a repeat of the 2008 market
crash and the Great Recession, or worse. Thus, they are priming the
monetary pump with news of the European Central Bank considering another
round of quantitative easing even as the central bank of China is aggressively
loosening monetary policy hitting the wires this week as the Fed holds
Moreover, the big banks are not alone, as the central bank of India
recently cut rates while the odds of other central banks such as Australia
joining the party are rising. Indeed, recent comments from Australian
bank governors have hinted at a change in the direction of rates, likely
to the down side as the Australian economy is slowing along with China’s.
Most important, while the Federal Reserve is on hold on its rate increases
news surfaced this week that the U.S. central bank may consider ending
its balance sheet unwinding by the end of 2019, a factor which would
further reduce pressure on market interest rates.
Altogether, the scene for what may be an aggressive round of global
central bank easing, led by China, seems to be unfolding. This is important,
not just for the global economy, but for the stock market because the
robot trading algorithms, the ultimate momentum traders, are programmed
to buy stocks, regardless of the valuation, as long as the interest
rate environment is considered to be positive for stocks and there
are buy orders coming in. Remember that the advance in stocks from
the 2009 bottom until the mini-bear market of 2018 was fueled by lower
interest rates and by corporate stock buybacks, which are back on the
front burner and contributing to the market’s current rally.
History May Be Repeating
Historically speaking, this market is being compared to that of 1991,
which happened to be a third year of a presidential cycle and where
the U.S. partook in Gulf War I. During the first quarter of 1991, the
S & P 500 rose 16%, 11.26% in January alone. Just as in January
of this year, the rally was preceded by a prior and sizeable decline
which began in August 1990 as the Gulf War situation, prior to the
deployment of U.S. forces into Kuwait, materialized. During that bear
raid in 1990, the S & P 500 was down over 15% in a bruising decline.
1991 was one of my best trading years ever.
Flash forward to 2018-2019 and we have a parallel situation where
a bruising late year bear raid caused by expectations of a trade war
between the U.S. and China led to what is currently a bear crushing
rally in January and February.
Interestingly, the Federal Reserve began a rate lowering cycle in
January 1991 after having raised interest rates from 1987 to 1989 and
keeping them stable until the Gulf War.
New High on Market Breadth
The New York Stock Exchange Advance Decline line remains the most
accurate indicator of the stock market’s trend, as it has been since
the 2016 presidential election, which is why its new closing high on
February 15 is a positive development for the bulls. Indeed, the new
high, barring a severe reversal in the near future, suggests that the
trend for stocks has now been fully reversed after the Q4 bear market.
Meanwhile the Nasdaq 100 (NSX) and the S & P 500 (SPX) have both
crossed back above their 200-day moving averages, at least partially
confirming the action in the NYAD.
Both indexes are nearly overbought (RSI) and overdue
for a consolidation which could come at any moment. But that consolidation
may not come for a while yet, given the fact that the On Balance Volume
(OBV) and Accumulation Distribution (ADI) indicators are still rising
while ROC, which measures momentum is not overheating.
Thus, with the rally broadening, the bulls may still get a couple
of more weeks of high momentum trading before some type of slowing
makes its way into the market.
Don’t Trust this Market. Just Trade it.
Don’t be fooled by the market. It’s not your friend. It will eventually
betray you, as it always does. But for now, it’s foolish to fight the
central bank fueled momentum as all indications suggest that the path
of least resistance is up. Furthermore, there are still plenty of doomsayers
out there calling for the end of the world, which gives rise to more
short covering as the market rises. Accordingly, even though there
are no guarantees, history seems to be on the side of the bulls at
the moment, given the historical parallels of the current time and
Of course, the bears may eventually be right, maybe even tomorrow
as the market loves to make fools of us all. Furthermore, the market
will be watching for the effect of any easing and it won’t be patient
if the data fails to turn around. But for now it makes sense to stick
with what’s working and ride the rising tide in the short term. On
the flip side, due to the market’s rally hedging is very inexpensive
at the moment. Thus it is worth looking at in order to prepare for
that inevitable reversal, which may be just around the corner.
Joe Duarte has been an active trader and widely recognized stock
market analyst since 1987. He is author of Trading
Options for Dummies, rated a TOP
Options Book for 2018 by Benzinga.com - now in its third edition, The
Everything Investing in your 20s and 30s and six other trading
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