-- This Week In The Money --

Analysis, Perspective, Trading Strategy

Stay Focused on what’s Working

Editor Joe Duarte in the Money Options

If there is a positive aspect of robot trading algorithms and their trading strategies it’s that they seem to have short memories, and they move fast. So as we witnessed in last week’s roller coaster ride on Wall Street, the difference between a bull market and a potential bear market these days may be measured in a few hours.

Certainly the September employment data was decent enough to rally stocks from a very oversold condition as short covering along with the fact that some are betting on a big push from the Federal Reserve to thrust stocks back into a bullish trend. Indeed it is plausible that the algos may buy into a “life could be worse” scenario and buy stocks at least in the short term, which means that the rest of us will follow.

But the most recent ISM sector data for both the manufacturing and service sectors suggests the rate of slowing in the U.S. economy is increasing. Thus, the danger for investors is that the bullish case based on the Fed saving the day could quickly fall apart especially if the central bank fails to acknowledge the reality of the moment and act more aggressively. Accordingly, Fed Chairman Powell, in a recent speech, did note that the U.S. economy “faces some risk,” which means that even he is starting to wake up to the perils of inaction.

Don’t get me wrong. I’m rooting for the bulls, in the markets, the economy, and life. But, even if the Fed really wants to prime the pump, its hands are tied because they don’t have a lot of room to lower interest rates, which means that they will likely start QE again, which may or may not work in the long haul. Thus with the business world and the public concerned about the politics in Washington and recession risks seemingly on the rise, it’s just as likely that people will keep their money in their wallets for the foreseeable future just in case things get even uglier as the presidential election cycle lurches forward.

That said, since the Markets-Economy-Life (MEL) complex adaptive system meets at the 401-K plan and the home equity line of credit (HELOC), a return to the bullish trend in the stock market coupled with lower interest rates may have a boosting effect on the economy as the psychology improves with consumers and thus the virtuous cycle could continue to unfold, warts and all. On the other hand, of some concern for MEL is the increasing number of reports of layoffs at diverse firms ranging from Kroger (KR) to unicorn ride service Uber, which may or may not be the start of something bigger.

It’s a tough call for sure. But given the impeachment situation, the uncertainty of the U.S-China trade war, the heating up of the Hong Kong protests and now the potential for European sanctions from the U.S. just as Brexit nears another deadline, it’s clearly not a time to take big risks as there are just too many things that can go wrong and cascade into a liquidity crisis of galactic magnitude. Thus, as traders we must continue to focus on following the money, what’s working, and on staying alive to trade another day.

Market Breadth Collapses and then Rebounds at Key Support

The three day decline and the two day turnaround in the New York Stock Exchange Advance Decline line (NYAD) was spectacular last week. Luckily for the bulls, the NYAD found support once again at its lower Bollinger Band, near its 50-day moving average after it crashed through its 20 day moving average.

 

 

So far, since the election on 2016, the 50 day moving average has kept the bull trend alive six out of the eight times it has been tagged. The only two times when the bears were able to crash through this key line was in February 2018 and October 2019. Of course the most recent breach led to a mini bear market. Thus, if the 50-day line continues to hold, the odds of a return to a bullish trend will increase given the past performance of this signal.

 

 

The S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes fought their way back from brushes with their 200 day moving averages to finish the week above their 50 day moving averages, which is a lot better than breaking to new lows.

 

 

That said there was less volume on the rebound than on the decline. That means that most of what we saw on Thursday and Friday was short covering. So if this is a new up leg, it will need more volume. Indeed On Balance Volume (OBV) remains in a short term down trend, so a reversal in this indicator would be very bullish.

A tale of Two Housing Markets

The latest ISM manufacturing sector data checked in at 47, a number that shows a rapid and accelerating contraction of the U.S. economy. Meanwhile a major component of the country’s manufacturing sector, homebuilders such as KB Homes (KBH) are reporting robust numbers and giving optimistic guidance with the unspoken asterisk being that new homes are selling well and are likely to continue to do so as long as the economy holds up.

 

 

As a result of this divergence between new and existing homes the housing sector is far from simple these days. Consider that even though new home sales may still have some upside left, likely boosted by low interest rates, the existing home market is in dire straits as prices for older homes especially many in need of remodeling remain too high.

More important, there are now emerging signs of what could become a seller’s panic attack. Familiar readers may recall that I’ve been following the travails of two existing homes in the up an up and coming young professional neighborhood over the last few months. Not surprisingly, even as I see new housing developments selling out rapidly in other parts of town, both of these homes remain on the market with one of them now dropping its price to $690,000. That’s $100,000 below its original offering price after being on the market for 194 days. The other one, which is next door to the one listed above has now cut its offering price to $760,000 from its original listing price of $796,000 after 196 days on the market.

 

The stock market is certainly voting with its money, as shares of new homebuilders are near their recent highs while shares of online home listing and marketing Zillow.com (Z), a proxy for existing home sales are near their 52 week lows. Of course, it doesn’t help that Zillow’s most recent earnings report was a huge disappointment due to higher than anticipated marketing costs.

 

 

Certainly the bond market is doing all it can to help the housing market, given last week’s return of the U.S. Ten Year note yield (TNX) to 1.5%, a decline which should help mortgage rates over the next week or two and could move buyers off the sidelines.

The bottom line is that the Markets-Economy-Life (MEL) complex adaptive system is nearing a major point of emergence, a decision point. In other words it is clear that price point and convenience are the keys to success in the housing market and that new home buyers, empty nesters, and move up buyers, the largest combined segment of home buyers, is currently willing to take the financial risk on more affordable new homes with amenities and prime locations than pricey older homes with a pending backlog of expensive repairs or features that need changing.

Now the big question is whether the economy will hold up well enough to keep the homebuilders in the money and if the Federal Reserve and the bond market will cooperate. A second question which must also be entertained is what may happen to homebuilder stocks if existing home prices fall to a point where these current wallflowers become price competitive.

Don’t Bet on the Fed to Bail the Market Out

The financial markets may learn a difficult lesson if the Federal Reserve doesn’t get more aggressive in the face of a slowing U.S. economy in the midst of an increasingly hostile political climate.

There is no sign yet that the market is in the all clear, although the last two trading days last week were encouraging. Moreover, even as savvy traders may be able to squeeze short term gains in the midst of the current volatility, until things in general don’t calm down, there is no point in taking big chances.

At this point it makes sense to hedge as needed, to raise cash as the market stops you out, to continue owning what’s working and to make a shopping list because in a market run by robots, the next bull run may be just around the corner.

Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best sellingTrading 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.

His latest Best Selling book 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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