Analysis, Perspective, Trading Strategy
Roll with the Trend - Don’t Fight the Fed. Don’t Fight the Market’s Momentum
By Joe Duarte on July 14, 2019
be clear. This is not a low risk market. Yet it’s the perfect time to
act as the late Marty Zweig always said: “Don’t fight the Fed and don’t
fight the market’s momentum.”
It certainly is a weird market and a stranger world for sure, so
it’s not really surprising to expect that the party could be over at
any time. But, even though things are messy, it doesn’t feel like 1999
or 2007 yet. What is evident is that as the wall of worry rises and
the endless talk about asset bubbles and recessions overwhelms the
airwaves and the financial pages, the stock market rally is picking
up momentum as the Federal Reserve has made it as clear as it can without
actually lowering the Fed Funds rate, that it is on the verge of a
new easing cycle.
More important, the bond market has not broken above its recent yield
down trend, which suggests that as long as external events, such as
the U.S.-China trade war and the election cycle don’t get out of hand,
the stock market, algo warts and all, is more likely than not on its
way to higher highs in the short and intermediate term.
It’s time to put MEL to a Test
Familiar readers are plugging into my Market, Economy, Life Stream
concept, (MEL) where the actions of the financial markets, the economy,
and individual and family life decisions converge into a streaming
continuum of activity forming a real-time self perpetuating cycle.
This time really is different. In the past, it was reasonable to
consider markets, the economy, and people’s lives as being much more
loosely connected than in the present. In fact, because of the Glass-Steagall
Act and the time required for actions in the markets to affect the
economy what happened in the markets was more dependent on the economy
than in the present.
Now, however, because of the repeal of Glass-Steagall there is no
dividing wall between the economy and the markets. And given the presence
of market trading algorithms in world where there is total interconnectedness
via mobile devices, the 24-hour news cycle, and social media, the markets
have more of an effect on the economy than vice versa and the effects
of one on the other are rapidly transmitted from the former to the
The Markets Lead the Economy and the People
Presently, the prevailing conventional wisdom is that we are heading
into a recession due to the U.S.-China trade war’s effect on the economy
coupled to the fact that many, especially in the middle class have
not recovered from the Great Recession and that job losses and the
end of the economic expansion are upon us.
In fact, the majority of economic thought argues against the Fed
lowering interest rates when the stock market is at all time highs.
But if they understood MEL, they would know that as the economy slows,
the trading algos start to bet on lower interest rates. They would
note that the algos trade based on prevailing money flows, which means
that at the moment, money is moving into stocks based on expectations
that the Fed will lower interest rates. Therefore because of the new
MEL dynamic, the markets, the economy and life’s financial decisions
now move in synchronous fashion fueled by the trend in interest rates.
What it all boils down to is that the new highs on the market are based
on expectations that the economy will fare better as the Fed lowers
rates. Thus as the mainstream worries about recession, the cycle of
expectations has already turned.
Certainly, things could change in a hurry and the whole world could
crash and burn. And it’s hard to argue with the fact that the U.S.
economy is slowing while many in the U.S. are struggling financially.
Moreover economic conditions in the rest of the world seem to be fading
Yet, if I’m right, because MEL is all about the markets, the economy,
and people’s life decisions moving together in the same direction,
as the Fed eases and the news spreads via the 24 hour news cycle and
social media, if there is a recession it may not be as deep or as widespread
as the mainstream line of thinking expects.
Accordingly, based on the basic tenets of MEL and the market’s current
behavior, I expect that the positive psychology of lower interest rates,
new highs in the stock market, and a stable bond market – barring a
meltdown in the latter – will positively impact the major tools of
current wealth, the 401-K plan and the home equity line of credit (HELOC)
and that will translate into a continuation of the economic expansion,
thus justifying the new highs in the market.
All of which brings me to the housing sector, the bellwether for
MEL at the moment. And as I describe in the next section, there are
some potentially powerful ways to play this area.
Location and Timeliness: Two Niche Housing Stocks with Huge
Housing stocks have been a hit and miss affair all year, but there
are two companies which should benefit from the current economic climate
as long as bond yields and mortgage rates don’t start a nasty rising
cycle and the job market doesn’t collapse.
One of the two is Skyline Champion (SKY) a designer and builder of
mobile and modular homes. With tight incomes, high demand for housing
and rising prices for traditional single family homes, SKY offers potential
homeowners a lower price alternative, especially for first time buyers.
The company has a large share of the mobile market, has its cost
structure under control and has recently offered positive guidance,
which is rare in the homebuilder sector in these turbulent times. Furthermore,
it’s expanding its manufacturing capacity in the U.S., which suggests
management is not just positive about the company’s prospects but that
it’s aware of the changing global landscape for businesses due to tariffs
and related matters and is making a big bet on the U.S. where the economy
and the demographics are in their favor. This is likely fueled by the
15% year over year growth in SKY’s home sales in the U.S., rising per
unit average pricing, and growth in revenues, gross profit and margins.
In the short term, the stock may gain further ground if its FEMA,
hurricane season sales, pick up.
The second stock is LGI Homes (LGIH) a regional
homebuilder, whose shares broke out of a multi-month base on July 12.
LGIH is well positioned for growth via its widespread footprint in
the Southern and Western U.S., especially in Texas, the Carolinas,
Florida, Oklahoma, Alabama, Nevada, Tennessee and Georgia, all areas
which should benefit from the migration from high tax states and stable
employment, a MEL related dynanic. LGI recently reported record breaking
second quarter 2019 home closing numbers with earnings due out on August
Both SKY and LGIH have positive money flow statistics including Accumulation-Distribution
and On Balance Volume.
Higher Prices Ahead Says Most Accurate Trend Indicator since
Once again, the New York Stock Exchange Advance Decline line (NYAD)
the most accurate indicator of the stock market trend since the 2016
presidential election made a new high this week, building upon last
week’s new high.
Furthermore, NYAD’s new high was confirmed by
both the S & P 500 (SPX) and the Nasdaq 100 (NDX) indices creating
a positive convergence suggesting higher prices ahead.
Perhaps the most encouraging sign is that the rally is starting to
broaden to include sectors beyond technology, which is both a bullish
and practical sign for stock investors as when more stocks rise so
does the chance of picking winners.
Roll with the Trend
We seem to be in the early stages of what could be a fairly profitable
momentum run for stocks based on new highs on NYAD confirmed by new
highs on the major stock indexes. Thus the burden of proof is now on
Therefore as long as the wall of worry is in place, it makes sense
to stay long the market via a sound trading plan:
- Trade with the trend but be aware that momentum markets always
- Be aware that the trend could turn against you at any moment
- Hedge only if now needed via raising cash, using inverse ETFs
and options, consider bonds as long as TNX yields remain below 2.1-2.25%.
- Use sell stops in the 5% range and let your winners ride while
cutting losses early.
As usual, trusting the market is not an option. Thus vigilance, moderation
in position size, and staying abreast of the overall market trends,
macro economics, the political situation and company fundamentals is
a must. Otherwise, enjoy the ride.
I own, SKY and LGIH 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
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