--Trading at the Edge of Chaos--

Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Caution is Warranted as Market Breadth is Deteriorating

Editor Joe Duarte in the Money Options

Is the stock market about to crash? The question is certainly coming up a lot these days.

While doing an interview this weekend at the Money in Orlando, host Hillary Kramer asked me if I thought there would be a crash in the stock market; to which I responded that anything was possible in the world at the moment due to the developing situation with the coronavirus and the overwhelming presence of trading algorithms in the stock market.

At the same time I also noted that it would be difficult to see the Federal Reserve reversing its current QE anytime soon, and since the algos just read headlines and follow instructions it was a tough call on what the market would do in the short term.

Nevertheless, and as I pointed out during my presentation on Friday morning at the Money Show before the interview, the New York Stock Exchange advance decline line (NYAD) may be in the early stages of a technical divergence, which is very worrisome if not reversed. I will have more details on this below. Just the same, however, the bottom line is that we are now truly trading at the edge of Chaos, where events are very fluid and where one false move can lead to disastrous consequences or riches beyond our wildest dreams.

Accordingly, the problem for investors is that if this divergence in NYAD becomes fully operational, we are likely to have a significant and perhaps very rapid decline in the stock market in which, regardless of the fundamentals for sectors or individual stocks, there will be pain felt throughout the Markets-Economy-Life (MEL) ecosystem. That’s because when the real selling starts, the algos usually just walk away and there are no buyers left to absorb the waves of selling. Of course, where there is risk, there is also opportunity, as I will describe below in the section regarding Gilead Sciences (GILD).

As a result, the effects of a market decline could work their way to 401 (k) plans, the pillar of the current wealth effect. And as familiar readers know, if 401 (k) plans suffer then people’s financial decisions, such as home buying, vacations, new cars, may be put on hold further decreasing economic activity. This in turn would make its way to corporate earnings and fuel more selling in the market.

Thus, we may be staring into a difficult abyss in the not too distant future unless something positive happens, especially in relation to the coronavirus situation. That said; it’s tough to know if and when things will unravel because there is so much at play politically in the U.S. Furthermore the Federal Reserve have a well founded fear of a full blown global recession gathering steam, which will likely keep the easy money taps open.

Bonds and Spilled Coffee

Still, it’s the Trillion Dollar question. Ultimately, a good way to visualize the relationship between MEL and easy money is that it’s akin to a worker that’s been going full tilt on overtime for a long time but is still getting good mileage out of drinking really strong coffee –easy money. However, if that worker is reaching the point of exhaustion then you might as well just pour the coffee down the drain because at some point the worker is going to need a break.

In other words, if the worker falls asleep, then production will falter. And that’s what the divergence of the NYAD may be signaling, that even premium strength java isn’t going to be enough to keep MEL rocking and rolling.

 

 

The bond market is certainly betting on the spilled coffee scenario as the U.S. Ten Year note yield (TNX) closed last week below 1.6% and seems poised to test the recent lows. There may be some hope out there though, as I point out below.

Does Gilead Sciences Have the Goods on the Coronavirus?

Is there a cure for the corona virus in the wings? And does biotech antiviral giant Gilead Sciences (GILD) have such a weapon in its drug arsenal?

The good news is that Gilead, an $80 billion market cap diversified biotech company specializing in antiviral medications, may have a potential remedy for coronavirus available and that it is currently being tested in China.

 

 

This story is clearly developing and there are no guarantees of success. However, the Chinese government began to use Gilead’s failed Ebola drug, remdesivir, in clinical trials involving 761 patients on February 6. The development came after Gilead reported improvement in symptoms within 24 hours in a U.S. patient in the state of Washington who received the medication.

Moreover, both Gilead and the Chinese government are keeping any news close to their vests at the moment although there have been rumors of great success with the medication during the trial.

Gilead is well positioned in viral treatments as it developed Harvoni and Sovaldi, the initial cures for Hepatitis C. It is also a leader in HIV treatments with a 79% market share in the U.S. while possessing a deep pipeline of current and next generation HIV drugs which provides $16 billion per year in revenues. Therefore if remdesivir makes a significant dent in the coronavirus, it could give Gilead a potential franchise against similar viruses in the future, not to mention that it could save a lot of lives in the present.

The stock has been trading wildly over in a protracted trading range over the last few months but did deliver a chart breakout on 2/7/2020. Certainly buying GILD for its prospects against the corona virus is highly speculative. Nevertheless, given the current alternatives for a break against the spreading pandemic GILD may not be a bad place to put a few bucks these days.

Here is a compelling summary of facts about Gilead:

  • Developed cure for Hepatitis C: Sovaldi and Harvoni
  • Excellent cash flow
  • Stout balance sheet
  • 4% dividend yield
  • Increasing footprint in Hepatitis B
  • Leader in market share for HIV drugs
  • Broad and diversified pipeline to include treatments for cancer and rheumatoid arthritis

Clearly this could be a make or break trade so the judicious use of a sell stop or the using of options to manage the risks involved is warranted. For more on managing the GILD trade, go here.

NYAD May be Signaling Market Weakness Ahead

The New York Stock Exchange Advance Decline line (NYAD) failed to make a new high last week despite a new high on both the Nasdaq 100 (NDX) and S & P 500 (SPX) indices. This is a technical divergence and until proven otherwise should be viewed as a potential sign that the market has made an important top.

 

 

Moreover, the On Balance Volume (OBV) and Accumulation Distribution (ADI) indicators for both SPX and NDX may have started to roll over although it’s still a tough call since a couple of good days next week could change everything again.

 

 

Furthermore, there are two additional findings in the NYAD chart which support the case for the divergence. First, the ROC indicator failed to climb above the zero point on the recent bounce. This confirms a loss of upside momentum which is evident in the lack of a new high for NYAD. Second, the RSI failed to get back to above 70, confirming that the broad market is starting weaken even as the major indexes made new highs.

 

 

Finally, NYAD ended last week at its 20-day moving average. If the line breaks below that short term support level it may well test the more critical 50-day moving average. A decisive break below the 50 day line is a serious breach and would likely signal an acceleration of the selling. As a result, until this technical situation is remedied the odds of the market stalling out are higher than of them making new highs and investors should be considering either raising cash, some sort of potential hedging for their portfolio or both.

Being Prepared for More Volatility Makes Sense at the Moment

The corona virus has created a dangerous background for the Markets-Economy-Life (MEL) ecosystem. Indeed the potential for the virus, due to quarantines in China, to cause supply chain disruptions, triggering a further slowing of the global economy, along with the immeasurable cost of lives lost may be the catalyst that finally disrupts the longest bull market in history.

At the same time it’s crucial to keep in mind that any sign of good news could reverse the current negatives in the market and theoretically start a new up leg. As a result, I remain cautious in the market and continue to advocate for raising cash, and to explore the possibility of implementing a hedging strategy, while remaining fully cognizant that the market could easily reverse and move higher at any

time. I’ll have more for subscribers in this week’s Portfolio Summary. For a 30-day Free trial subscription go here.

I have an open long position in GILD 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 books.

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.

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