-- Trading at the Edge of Chaos --

Analysis, Perspective, Trading Strategy

Bulls still have Hope but Caution is Warranted

Editor Joe Duarte in the Money Options

I remain hopeful and continue to play the long side of the market, albeit more cautiously than I was a month ago. This is because the uptrend is looking a bit tired and if the bearish trend reasserts itself, the negative repercussions would be felt far and wide along the Markets, Economy and People’s Lives (MEL) system.

At the same time, hope is by no means lost. For if, as I describe below, and as I discussed in my 4/24/2020 episode of Stockcharts.com’s: Your Daily Five, because of the Fed’s massive easing , and if there are signs that people are being successful as they attempt to get back to a more normal life an upside surprise may be in the offing. What that means is that if a couple of small, yet important things happen, especially on the technical side of the market, the bull trend could easily reassert itself, and perhaps in a fairly spectacular way.

Nevertheless in what remains a very fluid situation, it pays to be prepared for all possible contingencies, including considering hedging some bets while continuing to pick stocks near the sweet spot of the Complexity Zone.

Last week, in this space, I wrote: “we may be reaching a point where the balance between the components of MEL, the complex adaptive system comprised of the stock market (M), the economy, (E) and people’s lives (L) is nearing a point of emergence to a new level of operation. Foremost, if this is correct, then because of the way algos are programmed, the Fed’s actions are paramount.”

More specifically, I wrote: “my current analysis suggests that the markets are on the verge of becoming the leading component of MEL. This is due to the fact that 401 (k) plans are central to the wealth effect for many people. Thus, the stock market’s rally has been a psychological positive of sorts to those who may be temporarily out of work or are working part time.” In other words, in this new Post New Normal world, the markets are leading the economy, which means that a negative event in the stock market could easily derail any potential positives in the economy.

Of course, because we are at the Edge of Chaos, at this point anything is possible. Yet, if the market does roll over decisively, then by its actions it will be sending the message that despite the Fed’s unprecedented actions the MEL system has reached a point where the long standing structural problems: insurmountable debt, mismanagement of capital, and the maldistribution of wealth cannot be overcome by monetary policy.

Indeed, given the current state of the NYSE Advance Decline line, see below, the rally is at a crucial decision point. What that means is that for the first time since the market topped out and the rebound rally has developed, active traders may wish to consider hedging some of their bets, just in case the bear starts to growl again.

Leidos Holdings: In the Sweet Spot of the Government’s Super Nova Spending Stream

Under normal circumstances, Leidos Holdings (LDOS) is a well run software company with a plethora of government contracts and thus a fairly secure earnings stream. But now, when government bureaucracies are in Super Nova mode due to the coronavirus stimulus packages, Leidos may just surprise even those with the most optimistic of expectations as it continues to mine the never ending income strea

 

 

In the month of April 2020 alone, LDOS resumed work on a five year $450 million U.S. Air Force IT contract, while adding a $69 million IRS customer e-services software management contract. And this is on top of a banner fiscal 2019, where the company delivered over 10% year over year growth rates in key measures, including revenue, EBITDA, bookings and profit margins.

For example, in Q4 2019, the company inked a potential $7.7 billion contract with the U.S. Navy as part of a total of $18 billion in three separate contracts, two of which are still being negotiated. Meanwhile, the company booked a total of $14.5 billion in revenues for the full fiscal year 2019 and has a backlog of $24 billion in potential revenues on the books. Furthermore, the company continues to grow both organically and by acquisition in defense as well as most recently in healthcare where the COVID-19 situation is likely to increase the need for IT services due to telemedicine as well as electronic medical records.

The stock recovered nicely from its bear market drop and is now in the Complexity Zone, where systems operate optimally, above its 50 and 200 day moving average after breaking out above the $100 level on 4/24/2020. Moreover, the breakout came on rising volume and with confirmation from Accumulation/Distribution (ADI) and On Balance Volume (OBV).

Barring a major market debacle, LDOS could well make its way back to its all time highs near $125 over the next few months. For more on LDOS and stocks that are doing well in the current market consider a FREE Trial to Joe Duarte in the Money Options.com

NYAD Replays Negative Pattern Similar to Troubling Past

The New York Stock Exchange Advance Decline line (NYAD), the most accurate indicator of the stock market’s trend since the November 2016 presidential election may be tracing a negative chart pattern reminiscent of its action in October 2019 prior to a 20% decline in stocks.

 

 

Specifically, NYAD is struggling to stay above its 200-day moving average as it struggles with the resistance provided by its falling 50-day moving average. This, coupled with what could be negative divergences in the ROC and RSI indicators suggests that unless this is corrected stocks could be close to entering a new down leg.

 

 

Meanwhile, the S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes continue to play cat and mouse with key chart points. The former continues to bounce around 2800 while the latter is having trouble getting back above 8800, although both indexes ended the week above their 50-day moving averages, while NDX closed above its 200-day line as well, which are both encouraging signs.

 

 

Moreover Accumulation Distribution (ADI) and On Balance Volume (OBV) for both indexes stabilized by the close of trading on 4/24/2020. Therefore if NYAD is able to take out the overhead resistance at its 50-day moving average, the likelihood of new down leg in stock prices will be greatly reduced.

Hedging Starts to Make Sense

We are clearly in a no man’s land scenario as NYAD is stuck between its 50 and 200 day moving averages while sellers seem to be quietly moving back into the markets. Therefore, hedging long positions via inverse ETFs or put options may be a sensible trading tactic to consider along with tightening stops.

Nevertheless, it’s important to note that the uptrend, until proven otherwise remains intact. Thus, the focus of any trading strategy at the moment should be on stock picking along with risk management including keeping prudent levels of cash in trading accounts.

Of course, hedging, which has proven to be futile over the past twelve months as the market’s volatility has wiped out any short term benefits of the strategy may prove to be yet another dead end in this market. Nevertheless, because we are still waiting for the complete all clear in the market it makes sense to consider such a move at this point.

Indeed, the worst thing that could happen is that the hedge loses value if we get another up leg in the market. This, however, could easily be remedied by closing out any hedge positions while letting the open long positions move higher.

The bottom line is that in the short term, it’s not a bad idea to consider hedging in order to protect the gains we’ve attained since the recent market bottom.

I own shares in LDOS.

 

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.

A 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.