Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Short Term All Clear Appears. But it’s still all about Liquidity.
Duarte in the Money Options
market, as I thought might happen, has given the bulls a short term all
clear signal which means that until proven otherwise, the bulk of any trading
strategies should be geared to the long side. Nevertheless, as I describe below,
the system is far from being fully back on solid footing. Thus given the ongoing
uncertainty about the coronavirus and the global economy, risk management remains
a paramount objective.
As has become a customary ritual now, I must note that all things
in the world and the market could change by Sunday night as the futures
markets could open 1000 points up or down. Thus, investors should remain
wary regardless of the positive developments that occurred last week.
Last week I wrote: “The stock market is signaling that a big move
is coming. And although there is no guarantee, it could certainly be
an upside breakout,” while further noting “If I was an algo programmer,
I would unleash the BUY program to end all BUY programs as the way
to recovery for MEL will be via the 401 (k) plan wealth effect.”
Certainly somebody might have read my comments, maybe even an algo
or two. But, all kidding aside, more likely I guessed correctly based
on a clear understanding of the following relationships. MEL is a complex
adaptive system in which the stock market (M), the economy (E) and
people’s lives (L) are completely intertwined and function as a single
inseparable unit with the 401 (k) plan being a central agent in the
Here is how it works. When stocks rise, 401 (k) plans benefit, people
feel better about their financial situation and tend to buy things
based on the expectations that their financial futures are in good
shape. This in turns ripples positively through the economy and is
eventually reflected in corporate earnings. Rising earnings, even if
they are distorted by stock buybacks, pro forma assumptions, and non-GAAP
earnings trigger the algos to buy stocks.
The key to MEL, however, is that there must be commerce; specifically
the movement of dollars from one place to another via actual business
transactions, which are mostly done on credit. This is known as the
multiplier effect - the counting of a single dollar as if it were multiple
dollars as it weaves its way through the economy. Without the multiplier
effect, there is actually only one dollar in the system, not the appearance
of multiple dollars, which is what creates the perception that the
economy is moving.
Even worse, when this happens, as it clearly has recently due to
the coronavirus and the global economic stall, bank reserve ratios
are essentially worthless and the debt cycle comes to a complete halt.
Indeed this is why the Fed has to continue to pump money into the banking
system and why it won’t stop until things improve, if ever.
And although many economists ignore this fact, the algos are well
aware of it, and responding to the current status of this dynamic at
any time is clearly part of their programming. This is why the markets
stumbled in October 2019 during the repo market liquidity freeze and
in the fall of 2018 when the Fed raised interest rates to the point
where liquidity began to dry up in the banking system. When money isn’t
active, there is no economy. Moreover, when the algos took the major
indexes down 36% in three weeks in February and March, 401 (k) plans
got hammered; thus there was a clear and present danger to the economy
and the debt cycle, as frightened consumers began to hold back on their
purchases as they worried about their futures.
Therefore, this is the reality of the moment. If liquidity dries
up, the algos sell and the negative chain reaction through MEL unfolds.
Unfortunately, algos always overshoot, which is why what once might
have been a 10 percent correction now becomes a 35% bear market in
Certainly algos can certainly make money in bear markets. But if
the economy completely crashes, it is plausible to consider that the
stock markets would become much less profitable for them as trading
would slow to a crawl. Of course they would make money; just not as
much as they can make in a bull market as long as MEL is in the virtuous
part of the cycle where people are employed and people keep putting
money into their 401 (k) plans, and buying things based on their positive
expectations for the future while simultaneously fueling the passive
Furthermore, in a global economy where debt is insurmountable, in
order to boost the multiplier effect, the Fed and other central banks
have no choice but to continue to print money. And if you haven’t factored
this into your economic expectations, this will likely go on until
the end of time, or at least until there are signs that the global
economy can return to some semblance of normalcy, such as that might
Therefore, at this point, and until further notice, everything in
MEL is about the Fed and system liquidity as the algos, and anyone
who gets the reality of the moment, hopes that there is enough central
bank money floating around to justify the unleashing of relentless
algo buy programs with the side effect of keeping 401 (k) plans in
the black and by their direct relationship also keeping the economy
afloat. The flip side is that if the Fed closes the money spigot before
the economy shows some signs of recovery, the whole thing could reverse
and we’ll be back to 1000 point down days on a regular basis.
Starbucks Rallies in Face of Brokerage Downgrade
I’ve traded in and out of Starbucks (SBUX) in both my personal account
and have recommended the stock to my subscribers profitably over the
last few weeks. But three interesting things happened to the stock
last week which were very bullish.
First, the company announced that it was closing stores in Japan
as it issued below consensus earnings while pulling future guidance
for now. All of which prompted several Wall Street analysts to turn
bearish on the stock, well after the stock had bottomed and was in
the midst of a nice rebound. Indeed, as soon the ink was dry on the
downgrades, the stock rallied to a new high from its recent lows and
now has the potential to move back toward the $85 area if it can clear
resistance near its 50-day moving average.
This is a sign of relative strength and should be taken seriously.
Certainly the stock has come a long way in a short period of time and
we could see a stall in the price at any point. But as I noted here
a few weeks ago, the company’s board of directors and management showed
some serious spirit when in the face of the pandemic they doubled down
on their China investments and adapted their U.S. model to the current
The analysts may be wrong on this one because what I’m seeing is
a well financed company with a solid balance sheet and the ability
to withstand more of the current situation than others in the restaurant
sector. Furthermore, even though store traffic may have slowed, because
the company sells coffee and other products through grocery stores
and other outlets, their future sales may prove to be much better than
anyone expects by the next earnings report. Moreover it seems the market
is recognizing that as well. For more details on SBUX and other stocks
I’m looking at currently take a 30-day trial to Joe Duarte in the Money
NYAD and NDX Close above 200 – Day Moving Averages
The New York Stock Exchange Advance Decline line (NYAD), the most
accurate indicator of the market’s trend since the 2016 presidential
election, has given a short term all clear signal by closing last week
above its 200-day moving average. This is clearly a positive, but the
market still has questions to answer.
For one, NYAD still has upside resistance at its 50-day moving average,
and at some point it will have to make a new high to signal that stock
prices are likely to be in an extended up leg. Nevertheless, we’ll
take what we’ve got and see how things go.
The chart patterns for the S & P 500 (SPX) and Nasdaq 100 (NDX)
indices are also showing glimmers of hope, with SPX reversing its short
term trend back to the upside, while NDX delivered an encouraging close
above its 200-day moving average confirming the action in NYAD. Accumulation
Distribution (ADI) and On Balance Volume (OBV) have also improved and
the RSI is at its midpoint near 50 on both NDX and SPX, suggesting
that if money continues to move in, the rally can remain in place for
Now, if I was writing the script for the markets I would slow things
down and start a steady consolidation pattern to allow people to take
a breadth. But then, I’m not an algo so who knows what may actually
Stay Long but Stick with Short Term Trading for Now
The odds favor the bulls in the short term, as long as the Fed doesn’t
pull back on liquidity and the algos don’t get spooked.
I like what I’m seeing in this market, but I am still a bit wary
given the potential for unpleasant surprises. Nevertheless, at this
point all we can do is stick with what’s working. I am still proposing
small positions but it’s clear that some stocks may benefit from a
bit more room to move, so loosening some sell stops is not totally
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.