Analysis, Perspective, Trading Strategy
Total Interconnectedness and Why Sticking with the Trend is the Best Current Strategy
By Joe Duarte on June 30, 2019
better or for worse the world now moves in directions which are directly
dependent on the interactions between the financial markets, the economy and
real life. And this highly complex system is clearly at a crossroads, a fact
highlighted by tight trading patterns everywhere and hosts of people making
life changing decisions based on financial events and their effects on their
Furthermore, this now well entrenched dynamic is about to move decisively
as investors await the markets’ response to events related to the Federal
Reserve, the U.S.-China trade war and the fact that U.S. economic data
suggests a slowing in activity is under way.
Certainly, the resumption of trade talks between the U.S. and China
should have a calming effect on the stock market, the economy and life
in general, at least in the short term. But of course, the devil is
in the details, and much still depends on what the Fed actually does
in July and how the initial pledges exchanged between the U.S. and
China proceed over the next few weeks.
In addition, the bond market has already priced in a recession as
yields hover near the recent cycle lows. Thus, if there is a reversal
in bonds and market interest rates rise, the Fed could be in a huge
pickle. In other words, they may have to lower rates, perhaps aggressively,
if the weakening trend in recent PMI data, Fed regional surveys, consumer
confidence data, and business confidence numbers continues. Therefore
the real question for all involved is what the Fed does if the economy
is tanking but the bond market is beating to its own drum and market
rates are rising.
What Came First - The Chicken or the Egg?
Somewhere in the middle of the data, the markets and the politics
is this often overlooked truth, which is that economic activity is
largely influenced by psychology. And at this moment, aside from the
obvious structural problems in the world –seismic demographic shifts,
decades of off-shoring of U.S. jobs, the results of terrible fiscal
and foreign policy since the 1960s, and too much dependency on the
Fed to boost the economy - people are just plain scared. And a big
portion of the fear stems from the wild and wooly politics of the moment
along with the possibility that no matter who gets elected in 2020,
life as they know it may never be what it once was.
Indeed what we are witnessing is the old chicken and egg effect as
businesses and the general population both wonder what came first;
the chicken: current economic situation resulting from structural economic
factors or the egg: fear of what the general situation in the world
is doing to the economy.
The question is clearly rhetorical, but the practical response is
tangible as people are keeping their wallets closed and are unlikely
to open them until there is some assurance that general conditions
are stable enough to do so. This very basic human response to uncertainty
has set up a vicious cycle with the net effect being that consumers
are pulling back, which in turn is causing businesses to pull back,
resulting in a slowing economy.
The Market-Economy-Life Complex and Total Interconnectedness
Moreover because we are now living in a world where the economy,
the financial markets and daily life are one continuous entity – the
Market-Economy-Life complex (MEL) - events tend to occur and
develop in a fashion similar to a chain reaction.
This synchronous motion in MEL is highly influenced by the relationship
between the stock and bond markets, the economy and their direct effects
on the main instruments of wealth for the masses: the value of their
home, the home equity line of credit (HELOC) and the 401-K plan. Therefore
as the markets move, people’s wealth changes along with them prompting
personal responses which when aggregated into a critical mass create
a scenario where events, reactions, and outcomes are seamlessly intertwined
into complex and often volatile trends– total interconnectedness.
Furthermore, this total interconnectedness effect is magnified and
transmitted at the speed of light via the interaction between the algo
fueled markets, the 24 hour news cycle, social media, blogs, editorials
and the constant connection of the public to information via mobile
Indeed, as a direct result of MEL and total interconnectedness, many
are voting with their feet and are leaving high tax states in droves.
Others are buying and selling their cars and homes based solely on
the latest Fed action, the bond market and their direct effect on mortgage
rates and auto loans. Meanwhile some are overwhelmed by the complexity
of the situation or physically unable to adjust to the changing times
and sit the whole thing out creating bottlenecks and pressure points
at key points in the employment chain.
The upshot is that from a trading standpoint, this new and evolving
dynamic has created a constant wall of worry which continues to fuel
the bumpy, often frightening and generally bullish rise in the stock
market, which could well surprise the majority of traders by once again
making new highs.
Market Breadth Predicts Higher Stock Prices
The fear in the economy is starting to rise but the New York Stock
Exchange Advance Decline line (NYAD) made a new high to close the week
of June 28. And since this has been the most accurate indicator of
the market’s trend since the 2016 presidential election, the bulls
ended the week on top and the odds favor a continuation of the stock
This, of course, could change rapidly depending on what the market
makes out of the recent talks in Osaka between the U.S. and China and
what transpires from now until the Fed meets in July.
Neither the S & P 500 (SPX) nor the Nasdaq
100 (NDX) indexes confirmed the new high in NYAD, but both indexes
remain within reach of such a high so there is no major divergence
Indeed, the most telling chart of the week was
that of the U.S. Ten Year Note Yield (TNX), which closed the week just
above 2% as bond traders wait for what happens over the weekend in
Osaka between Trump and Xi.
Thus if bonds hold steady, it is more likely that the stock market
will respond favorably to the pausing of hostilities between the U.S.
Stay with the Trend for Now
The evolution of MEL and Total Interconnectedness is likely to be
a major macro influence on the markets for many years. And although
it may seem counterintuitive in a volatile market, the most profitable
action any investor can take at the moment is to trade with the general
trend in the stock market based on the actions of the New York Stock
Exchange Advance Decline line, aided by the general principles of sound
The five pillars of this approach include:
- Trading with the trend
- Being aware that the trend could turn against you at any moment
- Hedging as needed via raising cash, using inverse ETFs and options,
- Using sell stops in the 5% range and
- Letting the winners ride while cutting losses early.
Indeed, picking stocks in this market has not been easy, which is
why cutting losses early is crucial. On the other hand, owning stocks
has certainly has been rewarding when a good pick comes together and
it moves higher for an extended period.
Some stocks that have adhered to this pattern include MDT, TXN, BR,
LDOS, and FLO which are still in our portfolio. Meanwhile there are
others that are emerging from long term bases which share similar characteristics
to those four winners. One of them, which I’ve recently added is CRUS,
a semiconductor stock which should benefit from any good news in the
U.S.-China trade war. You can have a free look at my current portfolio
recommendations by clicking on the link below.
I own MDT, TXN, BR, LDOS, CRUS and FLO as of this writing.
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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