Analysis, Perspective, Trading Strategy
As the Year Transitions Monitor the Fed, the Election, the Bond Market and Key Sectors
Duarte in the Money Options
impeachment done for now, Brexit increasingly likely, and the U.S.-China
trade deal looking as if it is moving to a new and perhaps more constructive
stage and a plausible resolution investors will likely focus elsewhere and
the interaction between the bond market, the Federal Reserve, the 2020 U.S.
Presidential election, and individual sectors of the market offer plenty of
new sources of trading stimuli.
The most unlikely bull market in history is over ten years old and
continues to power higher, at least seemingly until the end of 2019.
That said; there is one major aspect of the end of the year trading
pattern which should be of concern to all investors, the steadily rising
yield on the U.S. Ten Year note (TNX).
Indeed as stocks have powered higher yields have
quietly crept up and with TNX trading just below 1.95%, a move above
2%, although it is not guaranteed to happen, is more likely as each
day passes. So why am I worried? Simply stated, the effects of rising
bond yields in this market are unknown. Under normal circumstances
rising bond yields in the face of an improving economy might be seen
as positive, as they would signal that the odds of a recession are
falling and that investors are selling bonds and buying stocks in expectations
of improving earnings and higher stock prices.
The problem even though the economy is not falling off a cliff, it’s
hard to gauge the real strength, other than on a regional basis. Thus
based on PMI numbers, a 2.1% GDP growth rate, and steady but not overwhelming
new and existing home sales among other economic indicators including
employment related data, the economy seems to be stable and doing fairly
well. But, it’s also clear that it’s not growing at a rate that would
justify higher interest rates.
In fact, in this case, as much as I hate to say it, the Fed is probably
right. This, of course, begs the question as to why bond yields are
rising, which means that bond traders might be worried about inflation,
or there is a growing risk of a liquidity event lurking and bond traders
are heading for the hills.
The problem with inflation, however, is that it’s not registering
in the CPI and other mainstream measures followed by the Fed, although
any trip to the grocery store or the gas pump in places such as California,
where I spent a few days a week ago could be an eye opener.
Tale from the Road : It Never Rains in California
but it’s certainly a puzzling Place
I spent three days in the L.A. area in mid-December, and saw some interesting
things related to the Markets-Economy-Life (MEL) ecosystem. For one,
the classic California calm was still evident in some places. This was
a huge contrast to Texas where there is a certain urgency to daily living.
But there were sudden evident contrasts as I drove. For one, as I drove
down just about any road, plush neighborhoods suddenly gave way to vast
vacant swaths of land housing landfills and industrial areas which, in
turn, transitioned into homeless encampments under freeway overpasses
and rows of campers, often with broken windshields and flat tires, parked
in rows along the roadways. Moreover, in contrast to Texas,
there were few homes for sale, and little construction evident, at
least in the areas I drove by. Furthermore, gasoline prices were nearly
double what I see in Dallas, yet airports, rental car agencies, restaurants
and hotels were full and no one seemed worried or stressed.
What I’m saying is that there is clearly an imbalance in the U.S.
economy, not just from one region to another, but in some cases from
one neighborhood to the next such as what I saw in L.A. And given the
huge political divide in the country, the odds are that there is going
to be something that sneaks up on MEL over the next few months or perhaps
years that will most likely be related to or have a negative effect
on the bond market, from where a chain reaction could well cascade
into the stock market, the economy, and people’s lives.
Big Pharma’s Sweet Spot is growing
In this market, sector specificity is crucial and one of the best
areas at the moment is the pharmaceutical stocks. This sector has been
quietly moving higher throughout 2019, as investors factor in rising
earnings due to an increasing number of potential blockbuster drugs,
especially in the area of cancer treatments. Yet, even though some
shares have delivered big gains during the year, barring a major macro
moment of market upheaval, the fundamentals for the industry are in
what seem to be a rapidly growing sweet spot.
Certainly, a stock I recommended recently, Eli Lilly (LLY) has already
had a big run in December after upgrading its outlook for 2020 and
releasing news that its beta cell lymphoma drug LOXO-305 delivered
favorable outcomes in a recent trial aimed at leukemia cases which
have proved to be resistant to prior treatments.
In addition, over the last few weeks there has been increasingly
action in Glaxo Smithkline (GSK), Merck (MRK), Astra Zeneca (AZN),
and Pfizer (PFE) as these former laggards are starting to move higher.
Ultimately, however, Pfizer, may just be the turnaround story for
2020 as it slowly recovers from losing its patent protection for its
blockbuster drug Lyrica and a host of management decision mishaps while
slowly building a new stable of potential blockbusters including the
enigmatic Vyndagel to treat what may not be as rare as it is believed
to be type of congestive heart failure.
potential billion dollar drug in their nerve growth factor inhibitor
(tanezumab) which is aimed at treating chronic low back pain. What
makes tanezumab most attractive is that it is not an opioid, which
means that the likelihood of it being accepted quickly in the marketplace
upon FDA approval would be significant, as insurers would likely be
pressured to pay for a drug which could potentially reduce opioid usage
and the potential for drug overdoses.
Moreover, Tanezumab may also work for osteoarthritis, and for cancer
related pain, which, if true, would expand its potential market share
dramatically on a global basis, especially as the global population
ages. More importantly, neither Pfizer or Lilly have any significant
competition in nerve growth factor inhibitors as several other companies
have shelved their own candidates due to severe side effects which
were not widely present in the most recent trial for tanezumab.
Bullish Trend is Intact but Market Looks Tired
The New York Stock Exchange Advance Decline line (NYAD) made a new
high confirmed by the S & P 500 (SPX) and the Nasdaq 100 (NDX)
indexes. This is a sign that the bulls are in control at the moment.
On the down side, however, NYAD is well above
its upper Bollinger band while NDX and SPX both gapped higher on the
day on 12/20. Both of these events are technical signs suggestive of
an exhaustion gap, which is often a prelude to a pullback or a consolidation
By the same token, even if a 2-5% pullback develops, the market will
still remain in a long term up trend. Nevertheless, it makes sense
to keep a very close eye on open positions over the next few days and
to err on the side of caution as any pullback could become a major
Key support levels are 8400 for NDX and 3190 for SPX. Moves below
those key chart points may take the indexes back to their 20 or 50
day moving averages.
Expect Profit Taking and Act Accordingly
The stock market is finishing the year on a high note and the odds,
for now, seem to favor another up year in 2020. But in the short term,
the market is very overbought and the odds of some sort of pause are
well above even. Thus, it’s not likely a bad time to take some profits
and see how things shake out next year.
Moreover, the action in the bond market will likely play a significant
role in the not too distant future if current Ten Year Note yields
climb above the 1.9-2% area. Likely hit the hardest, if that happens
will be the interest sensitive sectors, especially housing, utilities,
and dividend stocks.
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
Meanwhile, the U.S. Ten Year note yield (TNX) is trading in a The
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