Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Can the Chinese Corona Virus Overwhelm the Fed?
Duarte in the Money Options
edge of Chaos is increasingly active. Just as the ink was drying on the
U.S.-China trade pact, fears of a global corona virus pandemic originating
in China have emerged, providing the catalyst for selling stocks and buying
bonds on Wall Street.
For the last couple of weeks, I’ve noted that the Markets – Economy
– Life Ecosystem (MEL) seemed to be heading toward a decision point;
an excuse to sell increasingly overbought stocks. In fact, in my 1/20/2020
weekly summary I noted that the odds of a 3 to 7% pullback in the stock
market before the next attempt to rally stocks materializes were increasing.
And while we may have started that correction process last week,
with the corona virus potential Black Swan event as the catalyst it’s
worth asking if this viral pandemic scare can overwhelm the Fed’s repo
market undercover QE 4 process which has lifted stock markets to record
highs. Moreover, if things do worsen rapidly, what will happen if all
global central banks ease even more aggressively and the markets continue
to sell off?
It certainly seems that this virus is a very nasty infection, and
that the Chinese government seems to have been caught on its back foot.
So the headline reading algos don’t know what to do other than sell.
Specifically, and although it is very early in the situation, there
are yet no signs of containment of the virus and that it’s spreading
all over Asia and the world; with cases in France, Australia, Malaysia,
Thailand, Canada and the U.S confirmed.
Even more alarming, a computer
simulation of a corona virus pandemic conducted at Johns Hopkins
University in late 2019 predicted that there could be as many as
65 million deaths worldwide within six months if the virus is not
contained. The point is that we are now close to falling out of the
edge of Chaos and into Chaos itself as the algos follow their programs.
Furthermore, beyond the cost in lives, the questions for investors
over the next few weeks are:
- What does it say about, the markets, the economy and life itself
(MEL) if the corona virus can beat the lure of easy money?
- More important what does a potential pandemic of this nature,
if it comes to fruition and it can’t be contained, say about the
state of the world’s health care systems and the ability of governments
to function as caretakers of the public interest?
I’ll be speaking at the February 6 th Money
Show in Orlando about Trading at the Edge of Chaos and how any
investor can manage through the current crisis.
Watching Housing and Semiconductor Stocks As Correction Looms
Investor confidence took a hit on 1/25/2020. Moreover if the corona
virus is not contained we may see a contagion effect throughout the
U.S. economy as passive investors, especially 401 (k) plans feel the
pain of what could be a real bear market and hit the sell button. Of
course, it’s early, but even stocks of companies with good stories,
including a trio of bellwethers: Texas Instruments, Applied Materials,
and KB Homes, described below suddenly feature charts which depict
some serious wounds.
Clearly, the dramatic reversals in these three stocks suggest that
the current economic expectations may have to be reconfigured, in the
face of a potentially escalating flu pandemic around the world. This
is even more concerning as recent U.S. economic data has been mixed
as exemplified by PMI data released last week for both the service
and manufacturing service.
Furthermore, the bond market hasn’t been buying the tale of economic
strength that some have attributed to rising stock prices. In fact,
the U.S. Ten Year note yield (TNX) is trading near 1.7% which suggests
bond traders are predicting a severe decline in economic growth.
Yet, with the Fed on hold, and likely to be secretly leaning toward
more easing as key sectors of the economy decide whether respond to
positive supply and demand scenarios or to give in to fears of the
unknown, investors should be watching developments closely in the next
Looking at our bellwethers, we note that the doom and gloom crowd
recently pointed out that Texas Instruments (TXN) is closing two plants
in the Dallas Metroplex, which has been a fairly strong economic area
for the past few years. What they didn’t note is that in the same earnings
report, TI also noted it is breaking ground on a new factory a few
miles south of the two they are closing. In fact, TI is making the
switch, from a strategic point of view not as a sign of business problems,
as demand for its older analog chips is waning and the demand for new
chips is rising. Moreover, TI joined other companies in the tech sector
who have recently said that the bottom of the semiconductor cycle is
likely in place, although the company noted that at the moment macro
events would dictate the future.
And they were not alone. Until the corona virus hit the wires, shares
of Applied Materials (AMAT), the company that makes the equipment on
which all chips are manufactured, had been moving steadily higher as
demand for next generation chips; including those used in 5G and industrial
automation. Elsewhere in semiconductor land, shares of Dow component
Intel (INTC) rallied feverishly, closing near their highs for the day
on Friday after the company delivered a huge beat of expectations on
its most recent quarterly report.
Outside of the semiconductor sector, KB Homes (KBH) and other housing
stocks have been in rally mode, showing a nearly perfect inverse correlation
to the U.S. Ten Year note yield. In fact, existing home sales, which
had been lagging surprised positively in December, coinciding with
bullish reports from realtors and homebuilders. Indeed recent housing
data once again underscored that supply is nowhere near ready to meet
demand, which in any market usually means that the bullish trend is
likely to continue. But KBH also closed sharply lower on Friday, albeit
still within reach of its recent highs and well above critical support.
My point is that after a ten year “recovery,” until the corona virus
news, the U.S. economy still seemed to have some legs. Moreover, has
this suddenly changed?
The answer is maybe; since the Markets, the Economy, and Life (MEL)
are now one interconnected system. In fact, over the last four months
as long as interest rates have remained favorable, and the news has
been manageable, the odds have been on the side of the bulls. This
has been spurred by imbalances in supply and demand in certain sectors
of the economy, such as housing.
That said, however, if things truly unravel in China, which is a
huge unknown at the moment, and the virus truly becomes uncontainable
the bullish story could unravel as 401 (k) plans, and their wealth
effect are central to MEL and their willingness to take financial risks
based on their expectations of their future. Thus, if the stock market
breaks and it triggers a 401(k) panic, directly via individuals selling,
or indirectly via algo selling, then the negative repercussions will
ripple through the entire system, and the odds of a recession, and
perhaps worse may actually rise.
NYAD Rolls Over
The New York Stock Exchange Advance Decline line (NYAD) finally rolled
over this week, signaling that the market is heading for some sort
of correction. This, coupled with the fact that the RSI for NYAD has
been above 70 for several weeks, means that the rally is likely over
for now, barring something very positive happening to spur prices higher.
Elsewhere both the S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes
seized and reversed after early day gains on Friday. Indeed both benchmarks
seem destined to test short term support (20- day moving averages)
and intermediate term support (50-day moving averages) in the not too
If the indices and the NYAD break key support levels we may see a
move back toward the 200-day moving averages, which are roughly some
10-12% below the 1/24/2020 respective closing prices. Finally, here
are some key support and indicator levels to watch:
- NYAD 20 and 50 day moving averages
- RSI 50 for NYAD
- NDX and SPX 20 and 50 day moving averages
- RSI 50 levels for both NDX and SPX
Shorting this Market is Tempting but May be Dangerous
This is a dangerous time, and although the stock market looks vulnerable
and the thought of shorting it is tempting, it’s probably not a good
idea, at least not yet. This is because given the speed at which algos
can reverse course you may suffer big losses on the short side. Therefore
a better alternative is to raise cash, to build a shopping list for
the next rally, and to just wait on the sidelines until things clear
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
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.