Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Again! Market Struggles as the Fed Tightens Liquidity
Duarte in the Money Options
don’t like that phrase: “sell in May and go away.” But it certainly looks
tempting these days, especially after a dismal earnings report from Warren
Buffet’s Berkshire Hathaway (BRK/A) and news of the Fed reducing liquidity
I am much less bullish now than I have been in several weeks as the
technical underpinnings in the market, even prior to Buffet’s weekend
bomb, were suggesting that stealth selling was increasing just as the
Federal Reserve announced yet another
decrease in its QE bond purchases from an initial $75 billion per
day to the recently announced $8 billion per day.
As weird as it may seem, it makes sense to think of the stock market
as a bloodthirsty vampire that needs to suck blood from the living
fountain of Fed liquidity on a regular basis in order to continue its
gallop higher in a dismal economic environment. Indeed, what we’ve
seen over the last couple of months is that as long there has been
liquidity, stock prices continued to rise, regardless of economic fundamentals.
But it seems that is changing.
So what it means is that, unless the Fed starts to jack up its bond
purchases again, regardless of what that may or may not mean to the
long term health of the global economy or whatever economic theory
anyone adheres to, risk for stock traders is rising.
In Post New Normal World Weak Stocks Point to Weakness in
Last week, in this space, I noted: “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,” and I am not budging from that
general conclusion at the moment, other than pulling back from buying
stocks in the near future until things clear up just a bit.
Specifically, in this Post New Normal world where insurmountable
debt has tied up the money supply and people are out of work, central
bank liquidity and government bailouts are the only things keeping
any type of economic activity going. Thus, the stock market, because
it is the primary beneficiary of central bank money, is also the primary
indicator of where things in the real world are likely to head.
Moreover, if the stock market can’t continue to move higher, then
the premise that stocks are the leading influence on MEL, the complex
adaptive system composed of the markets (M), the economy (E), and people’s
financial decisions (L) may be short lived as the economic data has
been clearly dismal. In other words, if 401 (k) plans start to lose
their value, people will start pulling back on their willingness to
take risks and economic weakness will ensue.
Indeed, there is nowhere to hide from the macro data at this point,
at least looking in the rearview mirror, as housing, retail, and employment
numbers are all in collapse mode. Indeed, Buffett’s woes may be largely
related to his wide diversification into real estate, leisure and travel
over the last few years.
Perhaps, as I have also noted over the last few weeks, the worst
possible scenario is that the market decides that regardless of how
much money the Fed prints, the structural problems of the global economy:
insurmountable debt, intractable political divisions, generally poor
leadership, and the potential for widespread supply chain problems
will overwhelm monetary policy. I should also note that whether this
is true or not, all it will take is that a consensus that this is the
case forms in order to reassert the down trend.
On the positive side, with the U.S. trying to restart its economy,
there is always the potential for positive surprises. This, of course,
is not guaranteed, but it is worth watching. For example, I went to
the bank on 5/1/2020 and for the first time in several weeks, there
were actually lines of people making deposits especially on the business
drive through lane.
Of course this may have been stimulus money that just hit the mailbox
instead of money earned by businesses doing work, so time will tell;
but that was interesting for sure. That said, and especially in light
of last week’s market decline, it’s important to consider where we’ve
been and whether, if when and how, MEL rebounds, what that rebound
may look like.
DR Horton has its House in Order but External Factors Matter
Before the coronavirus bear market struck, the housing sector was
in great shape and was a bellwether for the U.S. economy. Boosted by
low interest rates and a favorable supply/demand equation, homebuilders,
such as DR Horton (DHI) were doing well with sales and profits delivering
consistent growth on a regular basis.
The good times were well highlighted in the rearview mirror of the
recent quarterly profits report for the company which was much better
than analysts expected. Certainly, DHI toned down expectations for
the near future for good reason; no one knows what lies ahead.
Flashing forward to the present, little has changed in some ways.
Housing supply is still tight. Baby boomers are still looking to downsize
and move to homes with conveniences and amenities. Millennials are
actually starting families and looking to move away from downtown apartments.
And mortgage rates aren’t likely to rise for a long time.
So, what’s the key? Sadly, the missing link is how the jobs market
will act, especially over the next few months. For with no jobs no
one will find credit, especially as standards tighten. What that means
is that as state economies reopen the jobless claims figures and the
monthly employment report will be under high scrutiny and will become
increasingly influential to MEL.
DHI is certainly well positioned for now. It is the largest homebuilder
in the U.S. It has adequate liquidity, owns its own mortgaging and
title operations, and is able to manage its assets efficiently. But
it is not immune from external factors such as the mortgage market,
especially the ability to sell its mortgages to the increasingly fragile
secondary market for securitizing and servicing. And it just took on
$500 million of debt through a bond offering.
What that means is that if there is a huge mortgage debacle, such
as what could happen if defaults climb to a critical level and the
mortgage market shuts down, DHI and the homebuilders are going to be
holding on to properties longer and may have to resort to lowering
prices and increasing buyer incentives in order just to keep cash flowing.
Moreover, if business starts to really crater, debt servicing maybe
Technically, the stock remains in an uptrend although it faces resistance
at its 200 day moving average. Accumulation Distribution (ADI) has
been very strong, but On Balance Volume has been neutral. ROC has been
strong, which gives it more positive than negatives technical points.
The bottom line is that DHI has control of its own operations, but
may be at the mercy of the mortgage market. What that means is that
if the jobs situation doesn’t show signs of improvement in the next
week or two, the market is likely to get impatient, and DHI is not
likely to remain immune from heavy selling.
NYAD Runs Into Resistance
The New York Stock Exchange Advance Decline line (NYAD) made a new
high from its recent bottom last week but almost immediately took a
hard hit, reversing course on 5/1/2020. Still, it remained above its
50 and 200 day moving averages, so the trend remains technically up,
even if the chart looks a bit ugly suddenly. But if the descent continues
and those two key support lines give, the odds of a full blown reversal
in the market are very high.
The Nasdaq 100 index (NDX) also had a troubling reversal but remained
above its own key support levels. The problem there is that Accumulation
Distribution (ADI) is looking a bit top-heavy and On Balance Volume
(OBV) is not acting all that well either.
The S & P 500 (SPX) has even bigger problems, as it is clearly
under distribution with ADI and OBV on the verge of turning negative.
The bottom line is that sellers seem to be overtaking buyers at the
moment as the bad news may be overwhelming the Fed’s money printing
as the major influence on stocks prices.
Liquidity is the lifeblood of this Market
When liquidity dries up, stock traders have a problem. Thus, regardless
of anyone’s understanding of how the world is supposed to work, the
world isn’t what it used to be. Therefore, when in the stock trading
pit, it’s best to be in tune with what’s working at any one time. And
right now it’s all about liquidity.
So if liquidity fades, the market will fall. And right now, it looks
as if liquidity is shrinking. As a result, it makes sense to raise
cash, consider hedging, and to refrain from deploying any new cash
into this market until things clear up just a bit.
I’d love to be wrong. But just in case, I’m playing it safe.
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
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