Analysis, Perspective, Trading Strategy
Preparing for All Possibilities: Hedge against the Fed while Building a BUY List
By Joe Duarte on July 8, 2019
are increasingly skittish and this week could decide what happens for
the rest of the summer and perhaps the year. Indeed stock and bond traders
are aggressively betting that the Federal Reserve is either going to indicate
that it will be lowering interest rates in the near future, or perhaps even
pull the trigger by lowering rates at its upcoming two day meeting.
What could possibly go wrong?
It’s tough to be a central banker these days and the Federal Reserve
has a tough choice this week. Certainly the U.S. economy is not collapsing
but it is in a state of flux. The problem is that things could change
in a hurry.
For one thing, aside from the Fed’s actions there are the ever present
U.S.-China trade war issues along with the newly rising tensions in
the Middle East which could affect the oil market. Meanwhile there
is the presence of algos in the market, which will magnify any event
and potentially put volatility on steroids.
What the market may have on its side is history. And since this the
third year of the presidential cycle, the odds favor rate cuts, especially
as the Fed doesn’t want a repeat of 2008 and doesn’t want to be blamed
if there is a recession.
It’s the Market-Economy Complex
This time is different. In the past we had two separate entities,
the market and the economy. And although there was a relationship between
the two, there was enough distance between them so that what happened
in the market didn’t always affect the economy fully unless the market
trend remained in place for an extended period. In other words, the
market often forecast what would happen in the economy.
But times have changed. Since the repealing of the Glass-Steagall
act, the markets and the economy are intimately interconnected into
a single entity, the Market-Economy complex. For many Americans, this
connection is via the 401-k plan and the home equity line of credit
(HELOC); both of which, in many cases fuel the average person’s wealth
No doubt, this linking of the markets and the real world has been
further magnified since 2008 by the speed at which news travels through
social media and by the adjustments the public has had to make to survive
since then. And of course, the one thing that binds them is the general
trend of interest rates.
Consequently because of this connection and the advent of social
media, everything happens at the speed of light in both places nearly
simultaneously. In effect people will make real life decisions such
as canceling vacations, reversing business decisions and waiting to
make major purchases in hours and days instead of weeks based largely
on the interest rate trend, the value of stocks and their composite
effect of their 401-k plans and HELOC accounts.
Therefore, because everything is now interconnected and news travels
at the speed of light the effect of the Fed’s actions on Wednesday
have the potential to disrupt both the markets and the economy simultaneously.
Bulls are still not fully in control
The New York Stock Exchange Advance Decline line (NYAD) made a new
high on June 13 but could not extend it into Friday. That means we
are still in a moderate state of doubt and that whatever the Federal
Reserve says and does on Wednesday will likely dictate the action for
the intermediate term.
The S & P 500 (SPX) rebounded after falling below its lower Bollinger
Band (BB) before reversing and crossing back above its 200-day moving
averages, but is nowhere near a new high, given the laggard technology
sector’s recently poor performance. SPX is now battling to move decidedly
above its 50 day moving average.
The Nasdaq 100 (NDX) struggled last week as bad
news from the semiconductor sector rattled traders. The index remains
above 200-day moving average, but it is facing what could be very meaningful
resistance at its 50-day moving average.
The Fed and the Bond Market Hold the Key
It’s all about the Fed and the bond market now. Investors may be
in for a wild ride on Wednesday afternoon after the FOMC releases its
statement and Fed Chairman Powell holds his news conference. The U.S.
Ten Year Note yield (TNX) is on the verge of new lows with the 2% yield
area just 9 basis points below the closing yield on 6/14/19
The Fed’s decision will have a huge effect on the markets, but it
will especially meaningful for two sectors REITs and housing.
For the past few weeks I’ve been pointing to real estate investment
trusts (REITs) as market leaders. Accordingly, it will likely be a
watershed week for the sector given the influence of the Federal Reserve
on the bond market. REITs have been mirroring bonds for the past few
weeks, thus if bonds tank, the REIT rally is likely to suffer or be
A similar picture is visible in the home builders sector (SPHB) where
falling bond rates have spurred increased activity in mortgages. It
will be interesting to see what happens in the home building stocks
after the Federal Reserve rate announcement on Wednesday.
Hedge against the Fed and Rejoice if you’re wrong
It’s hard to trust the Fed, so anyone who trades will be well served
by hedging their portfolio either through options or inverse ETFs.
If I’m wrong, the odds that the market takes off to new highs for the
next week or two should more than make up any losses from the placement
of prudent hedges.
Since I don’t know what the Fed is going to do and how the market
will react I am preparing for all outcomes. First, I am keeping the
stocks that are working in my portfolio but making sure I sell them
if their sell stop gets hit. Second I am hedging against the Fed. And
third, and perhaps most important, I have compiled a buy list if the
I added three hedges and six potential longs to my subscriber’s portfolio
that can be accessed free of charge by signing up for a Free trial
subscription to Joe Duarte in the Money Options by visiting the link
Joe Duarte has been an active trader and widely recognized stock
market analyst since 1987. He is author of Trading
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