-- Trading at the Edge of Chaos --

Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Something is about to Happen in the Markets, the Economy, and People’s Lives

Editor Joe Duarte in the Money Options

As many take time off to do the best they can under the strange new circumstances for Mother’s day celebrations, investors should prepare for what could be a significant and surprising set of events in the not too distant future as several distinct variables, political, behavioral and economic seem to be moving toward some sort of decisive move simultaneously. And if history is any guide, once the dam breaks we are likely to witness what could be a significant transformation in MEL, the complex adaptive system composed of the markets (M), the economy (E) and people’s lives and financial decisions (L) as it evolves to the next level of function in the Post New Normal (PNN) world.

Last week I noted: “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,” while adding, “I’d love to be wrong. But just in case, I’m playing it safe.”

I haven’t changed my mind, and I still remain long with a slight hedge. Moreover, the liquidity issue remains worth keeping an eye on, as the Fed, once again trimmed its weekly bond purchases, now taking them down to $7 billion per day. So, you have to start wondering about what the Fed is thinking and whether it’s relying on the algo led technically derived buying spurts to prop up stocks, or an alternative thought which would go against any set of reasonable expectations, which would be that real money is actually coming into the stock market.

My thought is that it’s most likely that the robots are responsible for most of the upside these days, as cash levels in money market funds remain high and hedge funds reportedly sit on the sidelines. Moreover, even in this risky market it’s not wise to fight the upside momentum or to fight the Fed, until it’s clear that they’ve cut the liquidity beyond whatever the critical level may be.

But here is something to consider. If the market keeps rising, how long can those sitting on the sidelines wait before they miss whatever is left of the rally?

MEL is not Dead, Yet

The reopening of the economy is under way, but it’s too early to tell how things will work out. Moreover, there are no guarantees of success or any way to predict whether the system will fail or thrive. All we know is that the agents in MEL are now fiercely interacting with one another and the environment and that the system is likely to make a move, perhaps in the next few days to weeks. Of course the direction of the move will depend on the events that trigger the emergence of the system to its next level, and how each individual component of the system reacts with circumstances as it makes its move. Nevertheless, one thing is clear, something is about to happen.

Of late, the markets have been the most influential component of MEL, with the net effect being that anyone who has a 401 (k) plan and who either timed the market correctly or just sat things out and waited has benefited from the recent and ongoing bounce in stocks while waiting for a return to work in order to have enough disposable non retirement related money with which to make financial decisions.

 

 

In fact, last week I featured homebuilder DR Horton (DHI) noting that since homebuilders were bellwethers during the economic period prior to the coronavirus crash, the performance of homebuilder stocks may offer clues to the pace of recovery in the Post New Normal present.

The stock certainly held up well enough after my article and even delivered a minor breakout, as it bumped up to its 200-day moving average. And why not, since the most overlooked economic data of the week was the fact that new home mortgage applications have been quietly climbing for the past three weeks behind record low interest rates.

The most recent data brings the year over year comparison to -19%, well up from -35% just three weeks ago. Furthermore, freeway traffic in Dallas, by my back of the napkin calculation based on personal observation, is about 65% of normal; well up from well below 50% just a week earlier. This suggests that the next number to watch for recovery clues is the weekly unemployment claims numbers and whether some sort of bottom develops there before any potential employment in monthly payroll numbers.

Indeed what we know is that complex adaptive systems, such as MEL, adapt to the environment as they look for their next point of emergence. And right now we are watching that process unfold as the system looks to move toward the edge of Chaos where its optimal level of function resides. Nevertheless, this won’t be a linear process, and there will be bumps along the way. What that means is that since COVID-19 is an agent of Chaos, it remains predictably unpredictable and that its status could change at any moment forcing readjustments in public policy and human behavior.

EBay Signals Valuable Future for Commerce in Post New Normal MEL World

The longer COVID-19 remains a factor, the more likely eBay shares will be likely to prosper. Indeed shares of long maligned and underperforming online auction and sellers’ marketplace eBay (EBAY) have been moving steadily higher since the market bottomed, highlighting the adaptive nature of complex systems such as MEL, where the markets, the economy, and people’s lives and financial decisions coalesce into a single entity. Moreover, the shares have powered higher with little fanfare as they have become a great place for stay at home transactions between individuals and businesses, especially in the re-sales category as pocketbooks are strained.

 

 

But the quiet period may be over as more investors discover the dynamic behind the stock’s rise, and its recent breakout, which is that eBay is becoming an alternative to Amazon.com (AMZN) for a specific set of buyers and sellers. From a price standpoint, it’s clear that eBay is more attractive than Amazon. But more than price, from a value standpoint, it’s clear that eBay’s P/E ratio of 7 is more attractive than Amazon’s trailing P/E of 110.

Certainly, this is a bit of an apples and oranges comparison from a business standpoint as eBay is strictly a marketplace while Amazon is a retailer that also offers a marketplace option. Nevertheless, over time, the current price pattern in the stock suggests that eBay has an excellent niche in the Post New Normal (PNN) world and that it can easily grow that niche without too much worrying about its gigantic competitor.

The company delivered an upbeat earnings report and positive guidance in late April as it continues to become an alternative place to buy and sell goods, even for brick and mortar shops in the PNN COVID-19 economy. Perhaps the brightest spot in the report was the 25% growth rate in advertising, which suggests that there is a social media component to the business that is starting to blossom in the new PNN world. This coupled with aggressive enhancements to the underlying technology used to list and advertise products suggests that as the PNN dynamic evolves eBay should be able to continue its growth pattern.

Technically, the stock continues to move steadily higher, delivering a new high on 5/7/2020 while remaining under steady accumulation with On Balance Volume (OBV) and Accumulation Distribution (ADI) continuing to highlight positive money flows.

NYAD Bends But Does Not Break

The New York Stock Exchange Advance Decline line (NYAD) bounced off of the support of its 20-day moving average, while

also remaining above its 50 and 200-day MAs. This signals that the U.S. stock market remains in an uptrend for now. Moreover, NYAD is now within one or two good up days from making a new high since the market bottomed.

 

 

The Nasdaq 100 Index (NDX) continued to power higher delivering its highest close since the market bottom while the S & P 500 (SPX) continues to struggle in comparison. Specifically, SPX remains below its 200-day moving average, which is a negative divergence from NYAD and NDX.

 

 

Financial and industrial stocks continue to pull SPX down as money is now moving into housing related, technology, and to some degree the very oversold energy sector.

 

 

Meanwhile other groups such as homebuilders and interestingly some restaurant stocks are more are experiencing improved money flows.

Trade One Day at a Time

It’s clear that we are in a strange world where the economic news worsens and the market moves higher as long as central banks keep infusing money into the banking system. Of course, this can’t go on forever, which means that either the economy will improve or the markets will fall.

Perhaps the take home message is that it feels as if we are getting closer to the point of reckoning, even in the presence of some wildcards out there which could surprise even the most astute of traders.

What it means is that trading with a day to day approach is a great plan. That doesn’t mean day trading necessarily, but it does mean that tomorrow may be a completely different day and that all positions should be evaluated, not just on their own merits, but also on their daily performance.

Finally, keeping an eye on what goes on in Washington and Beijing is not likely to be a waste of anyone’s time these days.

I own DHI and EBAY.

 

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.

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