Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Cautiously Picking Stocks and Managing Risk in an Evolving World
Duarte in the Money Options
traders are now balancing on a high wire as the rally off of the March
bottom is starting to show consistent signs of wear and tear while still offering
some opportunities on the long side. Moreover it is during times like these
that fortunes can be made or lost in a hurry and where staying focused and
following strict trading rules can make the difference between a great trade
or a painful day.
Accordingly as the election nears expect the unexpected. In fact,
as I write, the news is breaking that President Trump is scheduled
to make an announcement regarding a potential therapeutic breakthrough
regarding COVID-19. Needless to say, the news is likely to have an
influence on the stock index futures since the press conference is
scheduled for 5:00 PM Central time, precisely when the futures market
Of course no one knows what Trump will say or how his opposition
or just as importantly, the Federal Reserve will respond. All anyone
can say is that starting now we should all be prepared for things which
we have never seen or heard before and that can create market volatility.
A World in Transition and a Federal Reserve on the Bubble
As COVID-19 and its consequences are cemented into daily life, the
complex adaptive system comprised of the markets, the economy, and
people’s lives (MEL) has emerged into a new reality and we are witnessing
an evolutionary transition whose repercussions will be felt for years.
Moreover, for investors who can identify the dominant trends both on
the ground and in the stock market as the situation evolves, the potential
for profits seems to be just getting started.
Still, as I point out below, and as I’ve noted over the last couple
of weeks, the market’s breadth and a general lack of energy suggest
that some kind of pullback, consolidation, or even a correction of
some sort may be underway. What that means is that we will have to
work harder to find winners and to be more patient and disciplined
as we wait for the stocks to blossom or to require selling.
In addition, even though we are now in a higher risk environment
than where we were a few weeks ago I am not fully bearish yet. That’s
because no matter what the Federal Reserve says, especially at its
upcoming Jackson Hole, Wyoming shindig, they are still going to have
to pump money into the banking system or the highly indebted economy
will collapse. And that one factor favors at least some stocks rising.
In addition, whereas COVID-19 was the major influence on government
and central bank policy in the past six months, the next quarter and
beyond will likely be about these three major themes:
- COVID-19 fading as the lead headline story and becoming the major
underlying influence in the public’s behavior, thus affecting MEL
- Lingering Consequences: Exodus from major cities and a positive
effect on housing, a disruptive effect on the workplace and the supply
and demand equation for everything
- The Election – where seasonal tendencies lead toward higher stock
prices in the fourth quarter
It should be noted, that even though the Fed’s hands are tied, the
central bank’s most recent minutes suggested that the FOMC will be
aggressive in its addition of liquidity only as long as the economy
remains weak. So it’s important to be aware of the fact that the most
data, released last week, shows that the economy is actually on
the mend to some degree. My own view, however, is that the recovery,
such as it may be, is a regional situation influenced by the movement
of people from high crime, high tax areas that have been ravaged by
COVID-19 to areas where there has been less economic damage and the
perception of safety.
But the numbers are what they are, so it’s hard to know what the
Fed, given its national focus may or may not do. From a market standpoint,
the best guess is that unless the current correction in the stock market
turns into something very aggressive, even as the election season heats
up and the negative sentiment rises, the odds will still favor stock
picking. Nevertheless, it’s important to keep the following principles
in mind and to put them into practice:
- Take at least partial profits on positions which have gained 20%
- Expand your research focus beyond your comfort zone
- Stick with strong sectors and stocks
- Trade in small lots and don’t be in a big hurry to buy stocks
in the short term
- Look closely at lagging sectors for potential turnaround candidates
- Adjust sell stops to prevent losses beyond 5%
Housing and Niche Retail Remain Key Foci of Emerging Post
So far the housing stocks, such as homebuilder D.R. Horton (DHI)
have moved steadily higher as the housing sector is booming buoyed
by low interest rates, low housing supply resulting from the lack of
aggressive building in the post 2008 housing crash, the COVID-19 influenced
exodus from big cities, and the previously existing generational shift
demographics including baby boomers selling big homes and younger families
looking to buy homes.
Certainly, those are favorable fundamentals for housing. But beyond
homebuilders, two retail stocks, Best Buy (BBY), which is set to deliver
earnings this and Target (TGT), whose earnings blew out expectations
last week have proven to be welcome wildcards in winning portfolios.
Certainly both stocks, which I recommended several weeks ago before
their major breakouts, have come a long way.
But be that as it may, they are still under accumulation for two
- People are preparing to work from home for extended periods, which
favors BBY, and
- The need to furnish new homes and for bargain pricing on food
and household items which favors TGT.
Best Buy has captured a significant portion of the work at home market
via rising sales of laptops and technology related items. But under
the hood, BBY has also recorded rising sales of freezers and other
appliances as many are making long term improvements in their homes
in case there are repeating waves of COVID-19 and they need to hunker
down again. Meanwhile Target’s attractive pricing on home furnishings,
clothing, and home accessories as well as their grocery aisles make
their stores attractive for one stop shopping especially in the wake
of long term population shifts and migrations.
And while investors have recognized the value and growth potential
of housing and related companies such as Target and Best Buy during
COVID-19 and potentially its next phase, many of these stocks have
come a long way and are due for a breather. Nevertheless as the system
evolves, and as I describe directly below, there are other areas of
the market which should benefit as COVID-19 and normal life start to
For more on how to trade this market check out my latest episode
of Your Daily Five where I discuss five stocks that are tailor made
for crazy market. Click
In the Sweet Spot with Abbott Labs
As COVID-19 gets folded into the forever changed daily life of the
entire world a perfect example of a company which should benefit from
this evolution is medical equipment and pharmaceutical giant Abbott
Labs (ABT). For sure Abbott is not a sexy high flying medical equipment
company, but it is one which is quietly woven into the daily life of
millions of patients around the world and one which should benefit
as more people choose to stay home for their medical care.
Accumulation/Distribution and On Balance Volume (OBV) seem to be
ready to rise and the stock is nowhere near overbought.
NYAD Develops a Slight Divergence
I am watching the NYSE Advance Decline line (NYAD) closely now as
the indicator may be flashing a cautionary sign. Specifically, on Friday
8/21/2020 NYAD was down as the S & P 500 (SPX) moved decidedly
higher. This is not a good scenario unless it is reversed.
Things would be outright negative if NYAD breaks below its 50 day
moving average and the corresponding RSI indicator closes below 50
as that would trigger a Duarte 50-50 Sell Signal.
In fact, SPX didn’t just move higher, it along with the Nasdaq 100
index (NDX) made new highs. That means that we now have unconfirmed
new highs in the indexes that if not corrected soon would signal a
potential full blown correction lies ahead in the market.
As a result, while we continue to look for new stocks to own, it
also makes sense to be very cautious in this market unless this situation
is rapidly corrected.
Caution Makes Sense in Late August
There are still plenty of stocks with bullish chart patterns, but
the potential for a major technical divergence between the NYSE Advance
Decline line and the major indexes, which has just appeared, suggests
that there is no hurry to buy aggressively in this market until this
situation is corrected.
As a result, the best tactic at the moment is to protect profits
and to be very aware of how things develop over the next few days,
even as you make your shopping list and put some money to work in those
stocks which are exhibiting extraordinary chart patterns which are
supported by strong fundamentals and outstanding management.
I own shares in DHI, BBY, TGT and ABT.
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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