Analysis, Perspective, Trading Strategy
At the Edge of Chaos: It’s Careful Time as Dog Days of August Could Bite
Duarte in the Money Options
the month of August come the dog days on Wall Street, which traditionally
means low volume and sluggish markets. Unfortunately, when the algos see low
volume and few bids, the market often slides in big chunks, so this may be
a very tough August – or not.
Accordingly, unless we are truly near the ultimate top for the longest
bull market in history investors who continue to analyze the market
based on metrics of the past will continue to be bearish and miss whatever
time is left in this ongoing bull market. Happily, as I will detail
below, investors who dig deep into company fundamentals, management
moves, and crucial technical indicators, are more likely to be rewarded,
often in a big way. And this is even more true in a market where the
Federal Reserve continues to pump money into the banking system.
Last week, in this space I wrote: “For investors, at least in the
present, it’s not what the economy can do to the markets that matters
most. Instead it’s what the Fed can do to the markets, to 401(k) plans
and to trading accounts that should keep us up at night,” while adding
“we are in a new world, where in a complete reversal of traditional
relationships, the markets are driving the economy and the Federal
Reserve and global central banks are driving the markets.” And by and
large, nothing has changed.
Familiar readers know about MEL, the complex adaptive system composed
of the markets (M), the economy (E), and people’s lives, so I won’t
dwell on the fact that its existence is self evident. What I will note,
however, is that over the last several months, I’ve described a series
of influences on the market, which now are asserting their effect on
stock prices in a more decisive fashion and which have turned the economic
apple cart upside down and have in effect have placed the stock market
as the leading influence in MEL.
These influences are best grouped in “the big five” macro influencers:
- The Federal Reserve
- Demographic milestones
- Retirement and trading accounts
- High Frequency Algos
Specifically, while traditionally most stocks fall in tandem during
periods of economic hardship, the combination of the influences described
above has changed the playing field requiring a different analytical
approach to stock picking. In fact the whole stock picking dynamic
has been further turned upside down as the market adapts to the evolving
dynamic of the COVID-19 pandemic and the Federal Reserve’s response
to the economic collapse caused by the shutdown.
Moreover, as the stock market now rules MEL’s roost, we now live
in a world where bull and bear markets may coexist depending on how
the interaction between the markets, the economy, and people’s lives
shake out for individual sectors and stocks. Indeed, the final cog
in the machine is the machine itself, the high frequency trading algorithms
(HFT), whose instant reaction to headlines can change any market trend
What it all boils down to is that success in this market requires
a working knowledge of how these five influences affect stock prices
and how to best decipher and manage them.
In a Bipolar Market Follow the Money and Monitor Management
It’s foolish to believe you are in a bear market when the New York
Stock Exchange Advance Decline line (NYAD), as I describe below, makes
new highs on a regular basis. Indeed, by definition, when the NYAD
is moving higher, it’s due to the fact that more stocks are rising
That said, these are not normal times, thus successful stock picking
requires a wide ranging and in depth analysis of the market and individual
sectors and stocks on a regular basis. For example, if you limit your
analysis to ETFs, such as the Healthcare Select SPDR Fund (XLV), you
would correctly conclude that healthcare stocks have been in an uptrend
Yet a more in depth analysis would reveal that not all stocks in
healthcare are in a rising channel. Indeed, if you owned shares of
pharmaceutical giant Glaxo Smithkline (GSK) you would be lagging the
market while if you owned shares of biotech equipment and materials
manufacturer Repligen (RGEN), a stock I recently recommended, your
only question at this point would be how much of a profit should I
take and when should I take it?
The difference is that RGEN’s management recognized the fact that
COVID-19 changed the entire playing field in biotechnology and pharmaceuticals
and aggressively pursued the product lines that would benefit most
from a feeding frenzy in drug and vaccine research, while simultaneously
managing the risk to its workforce and its supply chain successfully.
The net result is that Repligen delivered a well above estimates earnings
report on 7/30/2020 and punctuated the report by raising its entire
year’s guidance significantly, a fact that was picked up by the headline
reading algos and the day traders who moved the stock decidedly higher.
Meanwhile, GSK, who is a major vaccine maker and should have had
an advantage against other vaccine players, somehow failed to get into
the COVID-19 vaccine sweepstakes early or convincingly enough and was
basically left out in the cold. Certainly Glaxo, a usually well run
company, could bounce back. But at the moment, the stock looks like
Moreover, the move in RGEN was not a huge surprise given the company’s
business and its central niche in biotech’s science and manufacturing
dynamic. Furthermore, from a technical analysis standpoint, RGEN’s
price action was forecasting that a positive surprise might be in the
offing, as it had the following characteristics well ahead of its breakout:
- Accumulation/Distribution, On Balance Volume (OBV) were rising
- The stock found excellent support at its 50-day moving average
while remaining above its 200-day line
- The stock cleared stout resistance areas near 100 and again at
120 as delineated by the Volume by Price indicator which cleared
the stock for a breakout in each case
In other words, because this is a treacherous bipolar market it pays
off to do detailed analysis of stocks on a daily basis. Furthermore,
if you only look at price charts, you’re only getting half the story.
Thus, in order to get the big payoff in this market it’s a requirement
to dig deep into company fundamentals, to understand the business,
to monitor management, and to discern what the technicals are saying.
NYAD Remains in Uptrend
The New York Stock Exchange Advance Decline line (NYAD), until proven
remains in a stubborn uptrend despite the market’s daily gyrations;
and as I describe above, those investors who do their homework will
reap the greater rewards in this market.
Still, the short term action in NYAD suggests that some sort of pause
may develop over the next couple of weeks. Thus, and although the risks
at this point are low, investors should beware of the possibility of
a Duarte 50-50 sell signal appearing. And just to refresh memories,
a sell signal is generated when NYAD falls below its 50-day moving
average at the same time the RSI indicator falls below 50.
The S & P 500 (SPX) also looks set to embark on some sort of
consolidation pattern. On the positive side, SPX remains above its
20, 50, and 200 day moving averages although On Balance Volume (OBV)
is a bit on the weak side in the short term.
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
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