Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Stocks Seem Ready for a Short Term Rest

Editor Joe Duarte in the Money Options

As 2020 comes to a close many of the worries and circumstances that have driven the market higher all year remain in place, and in many cases their intensity has risen. The upshot is that fueled mostly by what I’m seeing in the market’s breadth and the action in the bond and currency markets over the last few days I have begun to evaluate the ability of this market to continue on the current momentum run regardless of central bank intervention unless something else gives.

However, as the month of December rolls on, investors should keep two things in mind. One is that stocks are in a bullish seasonal period with the Federal Reserve providing the fuel for higher stock prices. The other, is that all momentum runs end badly and this one won’t be any different when its time comes.

Yet, as time passes it is possible that this uneasy truce between seasonality and central bank easing is reaching a decision point due to political developments. And how the bond and currency markets respond to whichever way any of these major situations break will be what dictates the action in the stock market, perhaps over the next several months or longer.

So, here is what we know:

• Options expire on December 18, a fact which could increase volatility
• Pfizer’s (PFE) COVID vaccine rollout in the U.S. begins. Moderna’s (MRNA) vaccine goes up for FDA approval
• The Fed will keep printing money and buying bonds and results of banking stress tests will go public this week. Meanwhile FOMC will meet on 12/16
• Other central banks will continue to join the Fed’s QE efforts
• In a zero-interest rate environment, stocks make sense since there is no other way to make money but this is not without risk
• There are three major political issues which are weighing on the markets and which may be decided in the next two weeks: the U.S. election, a second stimulus package in the U.S., and Brexit
• The global economy remains in an uncertain place due to the COVID-19 pandemic and the sporadic regional shutdowns of cities
• The bond market, because of the economic uncertainty, should be rallying in prices and yields should be falling but this is not happening very convincingly at the moment
• There may be some holiday and risk averse related liquidity issues as the year comes to a close putting the market at risk
  

Now, here is where the problem lies. The Fed is buying $130 billion worth of bonds (treasuries, T-bills, mortgage-backed securities and other debt instruments) every month and has been doing so since summer 2019. Yet, the U.S. Ten Year Note Yield (TNX) is actually rising. Moreover, TNX is nearing the 1% yield area, where it has not been in quite a while. And although bond yields did not cross above 1% as of the end of the week, the trend for yields seems to be up now as long as TNX holds above its 50-day moving average. What this tells us, until it is reversed, is that the Fed isn’t buying enough bonds to keep rates from rising, which means that if the Fed doesn’t crank up their purchases interest rates are going to rise. And of course, stocks won’t like that one bit.

Furthermore, when you look at the condition of the U.S. Dollar (USD), you see that the greenback has been in a bear market for several months. This, of course coincides with the Fed keeping interest rates low by buying bonds, since low interest rates usually lead to a lower underlying currency. But a closer look at USD shows that it is now very oversold and that usually means that money will look to buy.

But here’s where it gets interesting. A rising currency usually means that expectations for higher interest rates are creeping into the market. Even more compelling is the fact that the U.S. Dollar is still considered a safe haven. Putting the rising bond yields and the bottoming dollar together, especially when stocks are starting to look a little top heavy, you can see why this may not be a bad time to cash in some chips, or do a little hedging.

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Starbucks Shares Perk Up on Upbeat 2021 Guidance

Those of us who have owned shares in coffeehouse giant Starbucks (SBUX) got a nice jolt recently when the company updated investors on its expectations for 2021. Among the more interesting things related by the company were the following:

• While reaffirming 2021 guidance the company predicted 10-12% EPS growth for 2023-204
• Company will open 600 new stores in 2021 with a large China expansion as “life there returns to normal.”
• International expansion will increase via licensing partnerships
• Increasing reliance on drive-thru for U.S. sales

Of course, it’s a long way from now to 2023. But what’s most important is the fact that SBUX is essentially a MEL (Markets, Economy, and Life) bellwether. Because of its central function in people’s lives due to the wide presence of its stores and the fact that coffee is an instrument for work and pleasure, its sales and expectations are a fairly reliable way to gauge the general direction for MEL. Moreover, if their expectations and observations hold up, that would likely mean that the world might actually get over the COVID pandemic and return to some sort of normalcy.

The stock did pull back at the end of the week ending on 12/11/20 and it could easily enter a consolidation over the next few weeks. Thus, it will pay to stay focused on the Accumulation Distribution (ADI) and On Balance Volume (OBV) which remain supportive of the uptrend for now. As of this writing, however, although the shares may be a bit overbought, there is good support at the $98-$100 area.

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Market Breadth Narrows Suggesting Momentum is Waning

The New York Stock Exchange Advance Decline line (NYAD) has made several new highs in the past few weeks but the recent action suggests the market may be getting a bit tired. Of course, it’s difficult to tell whether this is a pause that refreshes or something that may last a while. But it’s not a bad idea to be a little cautious at this point.

Moreover, the RSI for NYAD has been above 70 for the past two weeks confirming an overbought status for the market while ROC has rolled over. In other words, the odds of a pullback of some sort, or at least a consolidation are rising.

The action in the S & P 500 (SPX) is similar to what NYAD is showing us. Indeed, the market looks ready to take a breath.

The Nasdaq 100 index (NDX) also looks to be finding a way to consolidate with the 20- and 50-day moving averages likely to be support. Breaks below these areas, though, could signal lower prices.

Market Looks Ready for Short Term Rest

The crosscurrents between the Federal Reserve and the politics of the moment are giving the stock market a reason to pause, at least in the short term. This is being complicated by the action in the bond market.

As a result, the next few days are likely to be full of sloppy trading days. A bit of a hedge may not be a bad idea to go along with some profit taking as well as the removal of any position from the portfolio which is not showing relative strength.

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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