Analysis, Perspective, Trading Strategy
Big Macro Shift Gets a Jolt from Saudi Arabian Bombing
By Joe Duarte on September 15, 2019
know you’re living in interesting times when the bond market takes a
dive and the stock market rises to within striking distance of its all
time highs. But when you add the intangible effects of what may or may
not be an oil price crisis after the attack on Saudi Arabia over the
weekend, it’s clear life as we know it won’t be the same for a while.
Before the attack, things were muddled enough as the expectations
for central bank interventions and the potentially unknown repercussions
of what could be helicopter money were poised to percolate through
the financial system just as Millennials come of age and the early
innings of the presidential campaign start to heat up. Moreover, as
the U.S. and China move on to the next stanza of their dangerous trade
war dance, and the geopolitical situation reaches critical mass (Brexit,
Hong Kong, explosive Middle East tensions, and rising potential for
regional conflicts everywhere) investors are caught in a quandary as
they ask the proverbial question: is it really different this time?
For several weeks I’ve been noting that a big move was coming in
stocks and that the bond market was the key to the entire puzzle. And
until last week, as bonds sold off and stocks rallied, it seemed we
were on the verge of a very intriguing and predictably unpredictable
period in the market as the very complex system that is composed of
the Markets, the Economy, and Life (MEL) was steadily churning to its
But now, after the attack on Saudi Arabia, we are once again in muddied
waters. Specifically, it will be paramount to see what happens to the
bond market after the attack, and if there is any effect on the housing
market as the Federal Reserve joins the rest of the world’s central
bankers in lowering interest rates at its next meeting and how the
bond market responds.
Accordingly, and although it may be too early for this type of calculus,
the bottom line for the entire MEL loop is whether the U.S. will fall
into recession and what happens to those that are expecting and betting
that Trump will lose the election, especially in the context of whether
the U.S. once again enters the regional conflicts in the Middle East
in a more active fashion.
Bond Traders Have a Decision to Make
The mainstream economists and media were betting on a recession,
but until the weekend attack on Saudi Arabia that was yesterday’s news
for bond traders. Consider the fact that ever since the Fed lowered
interest rates in July the entire market had shifted. Indeed after
the Fed’s rate cut bonds rallied and yields fell to just above 1.4%
on the U.S. Ten Year note yield (TNX). But as of the close of trading
on 9/13 yields had backed up aggressively and were near 2%.
Moreover, further supporting the “no recession” argument was the
fact, that barring the interest sensitive homebuilder sector (SPHB)
had been moving steadily higher despite rising bond yields behind fairly
decent home sales and mortgage with homebuilders giving moderately
positive future guidance. Nevertheless, even before the Saudi attack,
there was a widening schism between new and existing home sales with
the latter lagging due to poor affordability in many expensive older
houses with a need for remodeling.
It seemed, however, that homebuilders were adjusting by shifting
toward building smaller, more affordable houses to attract new home
buyers or those wishing to scale down. Moreover, the next few weeks
should provide more clarity on housing if TNX breaches the 2.0% yield
after what is almost a certain 25 basis point cut in the Fed Funds
rate by the Fed at its upcoming FOMC meeting, or if the Saudi Arabia
situation leads to another decline in yields.
Certainly, before the Saudi attack, the interaction
between the Fed and the bond market have roiled the interest sensitive
real estate investment trusts (REITS), which had become an attractive
place for momentum investors. Note the rapid decline in the S & P
REIT index (SPRE), which is now threatening to break below its 50 day
moving average, a development which is likely to accelerate the selling.
It is also important to consider whether the market is starting to
bet that there is an ongoing shift between apartment managers (REITS)
and homebuilders as we experience a demographic transition from high
priced apartments to more affordable and newly built single family
Cisco Systems: Under the Radar Value with 5G and Cloud Boom
When volatility increases, as is likely in the next few days as the
situation in the Middle East unfolds, caution is always the best approach.
Nevertheless, volatility often precedes opportunity, which is why it’s
important to build a shopping list to include stocks which may be attractive
after the dust clears.
Accordingly, it makes sense to consider that Wall Street’s recent
shift away from momentum toward value stocks is likely to favor networking
giant Cisco Systems (NSDQ: CSCO). The former high star stock from the
1980s has languished in the wallflower bin for the past several months
due to investor fears about the U.S.-China trade war and the lack of
a major catalyst to return it to its former glory days.
But over the last four weeks, CSCO has bottomed out and in the current
market, due to its 9.55 P/E ratio and the potential for an improvement
in the trade dynamic between the U.S. and China, the stock has the
potential to move back toward the high 50s in the next few weeks, barring
a drastic reversal in these two factors.
Cisco’s stock took a beating after its most recent earnings report
as the company cited a rapid decline in its Asia-Pacific-Japan business.
What really hit the stock was the CEO’s characterization of the decline
being due to China not even allowing the company to bid on projects.
On the positive side, however, is that the company is transitioning
its sales and product development cycle into a subscription model which
is still in the early stages of development. This will be a huge boost
when it kicks into high gear as corporations start to put their 5G
infrastructure in place as well as improving their capacity to deal
with rising cloud demands on systems.
The bottom line for Cisco is that the stock is inexpensive at a moment
when value is back in vogue at the same time that the company’s management
cycle is gearing up for growth in its business. Investors may have
to be patient, but it is possible that Cisco gets caught up in the
transition of momentum to value. If that’s the case, unless the entire
financial system collapses as a result of the Saudi Arabia attack I
would expect Cisco to move back toward the high 50s over the next few
weeks to months.
Market Breadth Points to Higher Prices
The New York Stock Exchange Advance Decline line (NYAD), the most
accurate indicator of the stock market’s trend since the presidential
election of 2016 has delivered a stunning breakout to new highs, suggesting
that the bulls were back in charge. Of course, the Saudi Arabia situation
is likely to have some bearing on NYAD, so we will have to wait to
see how things develop.
The S & P 500 (SPX) and the Nasdaq 100 (NDX) indices both ended
lower on 9/13 but had rallied for the prior several days. Moreover
both indexes are within reach of their all time highs.
The S & P 500 is showing relative strength behind the improved
money flow toward industrial, energy, and financial companies, while
there has been a mixed performance in technology of late.
Still, both indexes are above their 20, 50, and 200 day moving averages
signaling that the general trend in the stock market is up for now.
Big Macro Things Are Happening
It’s certainly hard to gauge the future of our complex and adaptive
world. A prime example of this dynamic is the weekend attack on Saudi
Arabia. Nevertheless, based on the recent action in the financial markets,
big money seemed to be betting that there was no recession in the cards
for the U.S.
Of course, nothing is certain, but if the bond market and stock markets
do not fall apart in the next few days, it would be supportive of the
view that the whole economic picture is going to change, which means
that the sector rotation we saw over the last few days might be just
beginning. It also means that the Federal Reserve may or may not start
a long term trade reduction cycle, especially if the U.S. and China
can come up with something that resembles a trade deal, or how the
situation in Saudi Arabia works out.
In other words, trade accordingly.
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
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.
Washington Post Color of Money Book of the Month is now available.
To receive Joe’s exclusive stock, option, and ETF recommendations,
in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
JoeDuarteInTheMoneyOptions.com is independently
operated and solely funded by subscriber fees. This web site and
the content provided is meant for educational purposes only and
is not a solicitation to buy or sell any securities or investments.
All sources of information are believed to be accurate, or as otherwise
stated. Dr. Duarte and the publishers, partners, and staff of joeduarteinthemoneyoptions.com
have no financial interest in any of the sources used. For independent
investment advice consult your financial advisor. The analysis
and conclusions reached on JoeDuarteInTheMoneyOptions.com are the
sole property of Dr. Joe Duarte.