-- Trading at the Edge of Chaos --

Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Breadth Breakout Provides Bullish Backdrop for Stocks Unless Bonds Think Otherwise

Editor Joe Duarte in the Money Options

We are in the early stages of the traditionally bullish end of year seasonal period in the stock market, in the face of record low interest rates, with a COVID vaccine near distribution and with a stimulus deal likely to come out of Washington before Congress breaks for the holidays. That’s a lot of positive excuses at the end of what has been a great year for the market but a horrible year for the world. So, for now, it’s more likely that the rally will continue in the short term.

The real question for investors, however, is what happens when surprising and unexpected events emerge that may spoil the party. A perfect example is what happened to stocks on 12/3/2020 when Pfizer (PFE) announced that the logistics of delivering its new COVID-19 vaccine were going to slow delivery and stocks gave up a significant portion of their gains. Moreover, as I note below, what if bond yields start to rise aggressively?

The Bond Market Could be the Fly in the Stock Market’s Ointment

As I noted last week in this space, the late Market Master, Marty Zweig, whom I am paraphrasing, used to say: “the times when I’m most worried are the times when I’m not worried.” And this week, my big worry is the bond market. So, while the Pfizer news is a perfect example of how things can change on a dime, in a market where zero interest rates are the primary catalyst for higher stock prices, what happens in the bond market may be even more devastating to the markets than an afternoon selloff due to a COVID related news item.

 

 

Consider a scenario in which bond yields, especially on the U.S. Ten Year note (TNX) rise decisively above 1 percent, especially if they do so in a hurry. If that were to happen, it is likely that program traders would sell bonds aggressively causing a rapid rise in market interest rates. This in turn would likely trigger aggressive robot selling in stocks; specifically, in interest rate sensitive stocks such as housing, healthcare, biotech, and even the energy sector which has been moving higher of late.

 

 

That’s a big chunk of the S & P 500 (SPX) that would likely see aggressive selling. And of course, as we’ve learned over the years, once the selling starts the bots don’t know when to stop, at least for a while. Moreover, compare the chart of homebuilder KBH with that of the U.S. Ten Year note above. Perhaps the most compelling point is how fast KBH shares dropped with a moderate uptick in TNX over the last couple of months. Indeed, this suggests what an aggressive selloff in bonds, and the subsequent rise in mortgage rates would likely to do one of the brightest portions of the U.S. economy; housing.

Moreover, the response in the bond market to the weaker than expected jobless numbers released on 12/4/2020 was surely interesting. Under normal circumstances, any sign of economic weakness usually sends bond yields down. But as we saw on 12/4/2020 yields actually rose in response and once again we are right up at that 1% resistance level. We will have to see how this plays out.

I have recently added some stocks to my model portfolio which may resist rising bond yields. Have a look with a Free Trial. Click here .

Software Double Header for the Times: Leidos and SS & C Holdings

Last week in this space, I highlighted Brinker International (EAT), a stock which broke out last week based on the fact that the company’s management had finally adapted to the current times and that the new strategies were starting to pay off. And while management’s adaptations to the times we are living in are a valid theme, this week I’m describing two companies where the times are actually adapting to their products.

 

 

Indeed, the theme is automation, and the software that powers the rapidly growing artificial intelligence and robotics. I certainly don’t want to get into an Isaac Asimov tale in this column, but it’s clear that automation, whether we like it or not is rapidly growing.

So, I want to start with Leidos Holdings (LDOS) a company whose software and engineering products finds its way into the U.S. Defense department with some regularity. Certainly, no one really knows what LDOS does for the Pentagon, especially with its National Security Solutions unit. But here is what’s important. The Pentagon pays its bills and LDOS bills them for a lot of money, which usually leads to a beat in earnings and more often than not upbeat guidance. Moreover, LDOS is a very active software vendor for state and local governments, two sub-sectors where the trend is for fewer workers.

 

 

On the other hand, SSNC is all about automating front and back office operations for financial services and healthcare firms. Again, here the key is that machines are doing more work, and that humans will be doing less work. Of course, this is not a good thing if you are a human. But since the markets are being driven by bots, it’s easy to see why SSNC shares seem poised for a breakout. Here again, this company has a good habit of beating earnings and giving upbeat guidance.

Perhaps where they both meet is in the fact that the market has been ignoring them both for a while. But that seems to be changing as both stocks moved nicely higher last week with LDOS delivering a decisive breakout and SSNC seeming to be make its move.

Both stocks are well in the Complexity zone, where things function optimally and are above their 50-day moving averages which can be used as an entry point on dips if the stocks hold there on pullbacks. Accumulation Distribution (ADI) and On Balance Volume (OBV) are both very encouraging and volume analysis and Volume by Price (VBP) is suggesting that there is no meaningful overhead resistance to contend with.

What’s the bottom line? Robot traders are liking robot stocks. And from a trading point, who are we to argue?

EAT, SSNC and LDOS are certainly stocks with high profit potential, but just this week I found more highly compelling stocks which I just recommended to my subs. Find out why I like these stocks by taking a FREE trial to Joe Duarte in the Money Options.com. Click here .

NYAD Breaks Out Makes Further New Highs

The New York Stock Exchange Advance Decline line (NYAD) has further extended its recent breakout a signaling a continuation of positive money flows into the stock market.

We also got confirmation on the new NYAD highs from the S & P 500 (SPX) and the Nasdaq 100 (NDX). What this means, is that at the moment, the uptrend seems solid and the odds of higher prices are favorable, unless, as I noted above, the bond market decides to rain on the parade.

 

 

Perhaps the most encouraging aspect of the current action in NDX is that it’s moving decidedly higher even as AMZN and NFLX are struggling. That means that the current move in tech is being driven by the more traditional technology sector, which has been lagging over the last few months.

 

 

Indeed, for now the trend remains up.

Don’t Fight Momentum but Don’t Get Complacent

The stock market rally seems to be shifting to a new, more aggressive gear. As usual, this is being driven by the Fed and its nearly constant money infusion into the bond market. Still, with bond yields rising, stock investors should avoid getting complacent.

So as usual, the key to success is not to fight the Fed and to be very precise in the stocks in our portfolios.

For more on how to deal with the current market checkout my latest Your Daily Five video here .

 

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.

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