Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Breadth Breakout Provides Bullish Backdrop for Stocks Unless Bonds Think Otherwise
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
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
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
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
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
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
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