Analysis, Perspective, Trading Strategy
Joyless Highs Tempered by Fear of the Fed and the Bond Market
By Joe Duarte on July 7, 2019
stock market made joyless new highs last week, but they still count,
even though they may be short lived due whatever emerges from the bond
market and the Fed over the next couple of weeks. Nevertheless, and highly
important, investors got a useful glimpse into the bond market’s psyche
as the sellers came out in force July 5 due to a stronger than expected
Still, the stock market recovered and should hang on to most of its
recent gains in the short term as long as the U.S. Ten Year Note Yield
(TNX) stays below 2.1%, barring extraordinary circumstances. This,
of course is why Fed Chairman Powell’s upcoming Congressional testimony
matters in the daily grind of the Markets-Economy- everyday life system (MEL).
When Stock Traders are talking about Bonds
It’s never good when stock traders talk about bonds more than stocks.
Yet given recent trading patterns in both markets, especially in the
context of shifting economic data, it’s likely this will continue in
the near future.
Certainly the truth is that nothing is settled at the moment, especially
when you factor in the velocity with which the Market-Economy-Life system
reacts to the flow of information. Moreover, the net effect of this
system is that every day people make life changing personal and business
related financial decisions at the speed of light; influenced by the
market’s effects on social media and the total interconnectedness of
modern life through mobile devices. Thus, economic trends that would
in the past take months could now occur in the space of days to weeks.
Furthermore, this phenomenon means that through this feedback loop
that connects all economic things, everyday people and the markets
are now intertwined as never before. Thus, the rapid ebb and flow of
economic data influences behavior at all points simultaneously and
the cycle becomes a perpetual feedback loop which affects the entire
system rapidly and constantly.
Bonds and Housing are MEL’s Heartbeat
MEL may be a new concept to the uninitiated, but anyone who takes
the time to look around with a keen eye could spot it if they know
what to look for. For example in my own neighborhood over the last
three months, there were about six homes for sale in a space of two
blocks. These homes came on line in the early spring and did not sell
for months. However, as soon as the after the Fed suggested it would
lower rates and the bond market moved yields below 2.1%, they all sold
within a period of two weeks with one of them fetching a well above
the market average price.
Indeed, the interaction between key components of MEL is equally
visible in price charts such as that of the U.S. 10 Year Bond Yield
(TNX) and the S & P Homebuilders Index (SPHB).
Notice that as TNX reasserted its decline in March and April 2019,
SPHB moved decidedly higher as investors began to factor in a potential
rise in demand for housing secondary to lower interest rates. This
positive money flow into housing stocks was also partially fueled by
somewhat better than expected results and guidance from homebuilders
who have recently reported earnings.
Note also that when TNX moved back above 2%, SPHB
took a tumble. This market event also coincided with a rapid decline
in demand for mortgages, highlighting the MEL effect.
The key chart area to watch is the 2.1-2.15% range on TNX. If yields
rise above this range decisively the next target is 2.2-2.25%. Thus
it is it plausible that if yields surge above these key chart points
all bets for this bull market in stocks and the generally positive
tone of U.S. economy are off, unless the Fed moves aggressively, which
may not be enough as it may come too late.
How things Could Unravel if the Fed Doesn’t Ease in July
Times have changed. Before President Trump, when globalization was en
vogue, weak international data led to all central banks to easing in
tandem. So if that was
still the case, the Fed would likely be not just talking about easing
but actually doing so along with other global central banks since the
global economy, especially China, Asia and Europe are weakening rapidly.
Just last week Samsung announced expectations for a significant slowing
in its mobile chip orders. Meanwhile Germany’s economy is teetering
while their government bonds are offering investors negative yields.
But here is where things could get dicey. Globalization has gibven
way to national interests these days. And since the U.S. economy seems
to be holding up better than other global economies, the Fed may decide
that it doesn’t have to ease in July, although this is not likely given
the fact that the central bank does not want to be blamed for the Market-Economy-Life
meltdown that is likely to follow such a decision.
Still, if the Fed doesn’t ease at least a quarter point, I suspect
MEL will move into hyper drive and the U.S. could fall into a psychology
induced fear driven recession with bond yields falling deeply below
2% accompanied by a severe and rapid drop in stocks as the U.S. economy
grinds to a halt.
Joyless New Highs are Still New Highs
If we lived in an algo vacuum, I would be betting that stock prices
are going to go through the roof. That’s because New York Stock Exchange
Advance Decline line (NYAD) made a new high on 7/3/19 and held its
own after the 4 th of July holiday despite a bond market selloff on
And, as I’ve noted repeatedly, since this has
been the most accurate indicator of the market’s trend since the 2016
presidential election, the bulls once more ended the week on top and
the odds favor a continuation of the stock rally, barring a nasty surprise
from the Federal Reserve, the bond market or both.
In fact, both the S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes
confirmed the new high in NYAD, which is a bullish confirmation of
the still in place up trend.
The bottom line is that the algos are ready to rumble higher and
that if the Fed and bond market cooperate we could see a blow off scenario.
Trade Cautiously with the Algo Trend
Risk is not low, and the major internal force in the markets, the
robot algo traders are on the bull’s side for now. Of course, algos
turn on a dime, which means anything is possible. Nevertheless, at
the moment, the best strategy remains to trade cautiously with the
trend and that means the algos. My, how times have changed.
Thus, I will repeat the five pillars of the trade:
- Trade with the trend
- Be aware that the trend could turn against you at any moment
- Hedge as needed via raising cash, using inverse ETFs and options,
consider bonds as long as TNX yields remain below 2.1%.
- Use sell stops in the 5% range and
- Let your winners ride while cutting losses early.
Finally, stay awake because even though the Fed should ease in July,
there is no guarantee that it will. If they don’t, things are likely
to get ugly very quickly as the algos reverse course and MEL goes into
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
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