-- Trading at the Edge of Chaos --

Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Preserve Capital. Prepare for the Bottom. Deploy Cash when the time comes.

Editor Joe Duarte in the Money Options

In this market, there are three prime directives: capital preservation, preparation for the end of the correction and the deployment of cash into worthy stocks when the right time comes; whether it’s in three days or six months.

Although the present is daunting, and the worst may still be ahead, investors should consider the possibility that at some point the coronavirus correction will end, that the seeds of the next rally – the Fed flooding the market with money via its recent rate cut and continuing QE may have already been planted - and that when the dust clears there will likely be a multitude of historical bargains to be had in the stocks of companies whose brands and business niches have been decimated by the recent selling spree.

Furthermore, if there are any positive surprises in the not too distant future, such as a quicker than expected vaccine or successful treatment for the virus, see Gilead Sciences (GILD) below, the odds of the bearish case disintegrating almost instantly are significantly better than even.

This is a Serious Situation

I don’t want to sound like, Chicken Little, Pollyanna or Goldie Locks, but there is no wrong in assessing the moment through clear eyes, nor in looking at the glass being half full, as history is full of examples of markets turning just as the end seemed near.

Of course, it’s obvious that the current situation is serious and no one knows when things will improve. In fact everything now is predictably unpredictable as we are in the midst of a cage fight between Chaos, the purview of complete uncertainty and Complexity where complex adaptive systems adapt to evolving sets of variables looking for a payoff. Paradoxically, Chaos is a complete and unpredictable mess while Complexity is a highly organized, rules based process within which systems function optimally based on the constant interaction and the feedback loop between the active agents in the system and the environment.

As a result, it’s important to understand the dominant features of the environment as well as the agents engaged in the daily activity of the system. Currently on the agent side we have the components of the complex adaptive system known as MEL, the Markets, the Economy, and Life (people’s financial decisions). On the environment side we have the coronavirus.

Moreover, Chaos randomly works toward total destruction while complex adaptive systems, such as beehives and MEL, work toward a payoff which eventually leads to the emergence of the system in the direction of an even more optimal operational state. Thus, the key to where MEL -a complex adaptive system whose payoff is the attainment of profit and financial wellness- will emerge depends to a large degree on if, when, and how Complexity can overcome the current Chaos. In the middle is the 401(k) plan, the center and vehicle of many people’s financial life and the effects of the current market on if, how, and when they will spend money.

For a full review of how Complexity and Chaos work in the financial markets, how I predicted the current trading environment well before it started, and how to survive and thrive in it, check out my Orlando Money Show presentation: “ Trading at the Edge of Chaos

That said, from an epidemiological point of view, it is reasonable to expect that what happened in China will be reproduced in the rest of the world and that the effects may be more dramatic as the virus grows exponentially for what could be an extended period of time. What that means is that as long as the viral footprint is increasing it will exert its Chaotic influence on people’s lives, on businesses, and on political institutions such as the Federal Reserve, Congress, the White House and the entire U.S. and global healthcare, financial, and government systems. This, of course means that quarantines, business closures, and unfortunately increasing death tolls will likely be present for a while.

Moreover, the news will certainly be grim in many places and there are likely to be a great deal of permanent changes that emerge in all global systems, including MEL as the world adapts to a new reality. Specifically, alliances will shift, supply chains will be remade, and the likelihood of new pockets of leadership in high places in both governments and corporations will develop and which will reshape global events for the foreseeable future.

As investors, it is important to recognize that change is unfolding and that adaptation will be the key to success. Thus vigilance and agility will be the keys to survival. Here are several key points to consider:

  • Stay patient
  • Keep high levels of cash in reserve
  • Develop and adjust your shopping list as events unfold
  • Be prepared to deploy capital into your shopping list based on market conditions
  • Be selective: Only deploy cash in the best possible trading opportunities
  • Trade Small lots
  • Use well placed sell stops (maximum draw down of 5-6%)
  • Prepare for more volatility and the potential for any rally to be a false start
  • Consider options where appropriate to minimize risk and to maximize profits but don’t overpay for contracts just to gamble and hope.

Finally, as I discuss below, if there is a positive announcement regarding a treatment or a vaccine for the coronavirus the bearish case will likely crumble; perhaps instantly.

Gilead Sciences Breaks Out: Bright Light or False Hope Against Coronavirus?

Shares of Gilead Sciences (GILD) a global biotech leader in combating viral diseases broke out convincingly on March 6, 2020 as the market is hoping that the company reports positive results on its ongoing phase 3 trials of its antiviral drug remdesivir. Clinical trials of remdesivir in the treatment of coronavirus are being conducted in China by the Chinese government while global trial, including patients in the U.S. is being conducted by Gilead.

 

 

This is purely a technical play at the moment, given the fact that all we know is that remdesivir has been proven to be effective in treatment of a handful of patients with coronavirus as well as having acted well against the virus in vitro- test tube - studies. But the chart is very compelling at the moment with the stock taking out long standing overhead resistance near $80 on heavy volume and confirmation from On Balance Volume and Accumulation Distribution (ADI).

That said, given the fact that a vaccine, if one can be developed is likely to be available perhaps by summer 2021, Gilead seems to have the upper hand at the moment, which is what the market is betting on. Interestingly, remdesivir – which is not a vaccine as some are erroneously reporting - has been around for a while and has had success in lab tests against the SARS and MERS viruses, which are corona viruses. Thus, for now, GILD gets the benefit of the doubt based on remdesivir’s lab test background, the small sample of known real life successes on coronavirus patients, and the fact that the stock has momentum. Moreover, with little else on the horizon for eighteen months, barring an unexpected vaccine breakthrough, remdesivir seems to be the only show in town.

Of course, there are no guarantees, and the wait for the current clinical trial results is likely to be over by April, so the trade may not have much time left. My premium subscribers have been actively trading GILD profitably for the past couple of weeks. To subscribe for a free 30 day trial click here.

Bond Yields and Market Breadth Collapse Simultaneously

The U.S. Ten Year Note yield (TNX) and the New York Stock Exchange Advance Decline line (NYAD) are both in collapse mode as investors price in the potential for a significant global economic slowing and a subsequent decline in corporate earnings. The effects of this dramatic decline in yields on the mortgage and housing markets should be carefully monitored.

 

 

Indeed, the declines in both key benchmarks are impressive, they may still both fall further, although the declines seem to be overdone in the short term. Of the two, TNX is the most extended as measured by the extent it has traded outside of its lower Bollinger Band. On the other hand, NYAD still has room to fall, perhaps as low as its 200-day moving average.

 

 

Meanwhile, the S & P 500 (SPX) has broken below its 200-day moving average, a very bearish sign, which if not reversed will signal the possibility of a bear market.

 

 

Finally, the Nasdaq 100 (NDX) index is not far from breaking below its 200-day moving average, which if it occurs would confirm the possible arrival of a bearish trend.

It’s Always Darkest before the Dawn

The current market is extremely challenging. As a result, it makes sense to keep up with developments, make a shopping list, follow a sound trading plan and stay patient. This market will eventually bottom and there will be many bargains to consider. All we can do is hope to stay healthy, stay awake and avoid foolish trading mistakes.

Disclosure: I own 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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