-- This Week In The Money --

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

Let’s 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 latter.

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 even faster.

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 Upside Potential

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 6.

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 2016

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 the bears.

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 end badly

  • 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 Everything Investing in your 20s and 30s and six other trading books.

Preorder the second edition now of The Everything Investing in your 20s & 30s at Amazon and The Everything Investing in your 20s & 30s at Barnes and Noble.

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