Analysis, Perspective, Trading Strategy
A Slow and Steady Economy is no Match for the Fed Draining Liquidity from the Markets
Duarte in the Money Options
went on a wild and woolly roller coaster ride last week as tensions between
the U.S. and Iran rose to a fever pitch before calming down by week’s
end. Nevertheless, the odds of more drama in and out of Washington seem to
be on the rise, as the impeachment trial looms, which means that the likelihood
of more market volatility is almost certain to increase.
Meanwhile away from the news cycle and the volatility of the overnight
futures markets, the Markets-Economy-Life Ecosystem (MEL) is crafting
its own story. Moreover, the story is one of regional patchiness with
steady at best forward motion. This type of slow and steady activity
was exemplified by the less robust than expected non-farm payroll number
released on Friday along with other recent economic data. The bottom
line is that for now slow and steady may be the best that anyone can
expect. And whether that’s enough to keep the market moving higher
at a fever pitch remains to be seen.
Perhaps the most dangerous external influence on the markets is whether
the Federal Reserve begins to drain the liquidity from its Q4 2018
Repo market rescue operations, especially as corporate buybacks slow
during earnings season. If the Fed makes a bad decision, especially
in an aggressive manner, things won’t go well for stock investors.
Housing Story is still unfolding: Lennar Wins Big as KBH
Limps due to Bay Area Issues
I’ve focused on the housing sector over the last twelve months given
its bellwether status on the state of the U.S. economy. Moreover, as
I’ve stated in past articles, there is a massive demographic shift
in the U.S. at the moment that is driving demand for new houses. This
is due to Millennials reaching the family formation stage of their
lives, aging empty nester baby boomers moving from Mc Mansions, as
well as the migration from high tax states to low tax states with stronger
Certainly, the U.S. economy has slowed some of late, for whatever
reason – trade wars, Washington politics or just the fact that the
“recovery” and the bull market in stocks are over a decade old. But
even so, not all areas of the economy are slowing simultaneously.
For example, recent data from the National Association of Realtors
revealed that homebuyer interest surged in December as demand for non
refinance mortgages rose. At the same time service ISM data has stabilized
while homebuilders Lennar (LEN) and KB Homes (LEN) delivered somewhat
mixed but generally positive earnings reports and positive guidance.
The former beat expectations on both earnings and revenues while
the latter missed on its revenues, but not its earnings or its outlook.
Moreover, where both companies agreed is in their future guidance as
bookings for new homes have increased, while the average sales price
is slightly below last year’s and promotions have returned in order
to boost sales.
Still, inside Lennar’s earnings call there were a few nuggets worth
noting which are telling of the current economy’s resilience:
- Lower interest rates have stimulated demand
- Traffic and sales continued to strengthen
- Slower price appreciation is evident
- The entry level is leading the way
- Customers note risk is worthwhile due to stability in the economy
and the job market
So, the issue for KBH’s revenue miss may be due to its own set of
problems, especially geography. Indeed KBH’s revenue miss resulted
from their inability to meet their delivery goals in the Bay area of
California due to that region’s power blackouts and fires preventing
the company from installing key infrastructure such as plumbing in
homes which were being built.
Of course, this may have been a one-time event or not. Certainly
over time, it’s plausible to consider that these types of events may
repeat. After all, California has fires every year. And the power generation
issues that plagued the state are far from being resolved. Furthermore,
migration from California to lower tax states is likely to continue
and may also begin to take its toll on the company’s top and bottom
line on a more regular basis unless they make some important decisions
about their business involvement in the state.
Nevertheless, KBH improved its margins, a rise in its orders and
its backlog while cutting its leverage and debt significantly strengthening
their balance sheet. Furthermore, KBH remains bullish about its future
due to supply not being able to meet housing demand, which may make
the recent dip in the shares worth considering as an entry point.
Interestingly, the U.S. Ten Year note yield (TNX), after swooning
in response to the U.S.-Iran situation remains in a trading range,
well under the 1.9-2% caution zone. Indeed, if bond yields remain subdued
it may be the one factor what prolongs the good times for the homebuilders.
Market Breadth Looks Tired
The stock market didn’t crash last week, which is a big positive.
However, the NYSE Advance Decline line looks a bit tired. Thus, we
could see some sideways action or even a small pullback in stocks over
the next few days, although every recent dip has been aggressively
bought by traders who missed the December rally.
Specifically, the RSI for NYAD has been above 70 for the past couple
of weeks. Previously, as the chart shows, forays of the indicator into
this area since the 2016 presidential election have preceded some type
of rolling over in the stock market. The good news is that if NYAD
can stay above its 50-day moving average, the odds of a resumption
of the rally will be well above average.
The S & P 500 (SPX) made a new intraweek high along with the
Nasdaq 100 (NDX) index confirming the intraday high by NYAD. So for
now, as we’ve noted repeatedly over the last six weeks, the bulls still
get the benefit of the doubt, more over the intermediate term than
the short term.
Incidentally, I will be discussing the ins and out of the NYAD and
the Markets-Economy-Life (MEL) Ecosystem during my “Trading at the
Edge of Chaos” presentation at the Orlando
Money show in February and hope to see you there.
If the Fed Stays Calm Expect a Steady Economy and More Volatile
So where does the current status of MEL leave us on the stock market?
Certainly the politics, both domestic and international will have a
greater effect on the daily price swings in all markets. Furthermore,
with 80% of the trading being done by machines and a major portion
of the buying coming from corporate buybacks, it’s foolish to be outrageously
bullish but equally dangerous to tough to turn outright bearish, which
means that for now, we continue to stay the course and stick with what’s
Finally, two things are clear. First, given the ongoing intraday
swings in the market, investors who watch stocks closely on an intraday
basis may make buying and selling decisions which by the end of the
day may lead to heartburn, which means that stock picking and patience
will be in high demand in 2020. Second, and even more important, keep
an eye on what the Fed does regarding the Repo market liquidity it
infused during Q4 2019. A sudden hiccup in the credit markets, especially
if corporate buybacks slow will likely have very negative repercussions
I own shares of KBH as of this writing.
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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