Analysis, Perspective, Trading Strategy
At the Edge of Chaos: GameStop May Get Headlines but the markets to watch are Bonds and the Dollar
Duarte in the Money Options
As the weekend evolved the news of repercussions
from the GameStop short squeeze included expectations for a short squeeze
in the silver market and other potential developments. Thus, by the
time the futures markets open on Sunday night events could be quite
Man, 2020 was getting a good start if you owned stocks as the Fed’s
QE wind continued to blow favorably into the bull market’s sails. But
in a heartbeat the world changed last week as these potential trend
changing events developed:
- The public gave the hedge funds a black eye and the stock market
- The Fed again told the markets it would keep interest rates low
for a long time and the market fell on the news as they worried about
the troubling issues at Robin Hood and perhaps most importantly
- Bond yields resumed their recent climb and are on the verge of
an upward breakout which suggests that the Fed is falling behind
on its bond purchases or that there is more inflation in the system
than what is showing up on CPI and PPI
So, with the day traders creating what some are calling an “inmates
running the asylum” scenario and the technical deterioration of the
market accelerating on Friday, we must ask whether historical precedents
in the market regarding what can be done in case of systemic liquidity
crisis are still applicable.
Moreover, we must ask whether the situation at Robin Hood and related
brokerages as it pertains to the so-called GameStop (GME) short squeeze
has reached critical mass. In other words, have one or more critical
players in the payment chain: brokers, clearing houses, or very large
become illiquid and is thus not able to make good on its obligations.
And if such a situation is developing, how much worse will the problem
become as risk stemming from options and/or unknown over the counter
derivatives becomes operational and apparent and the selling spreads
to not just stocks but other markets?
Certainly, if things escalate the risk that the banking system would
freeze would rise significantly. In that case, the Federal Reserve
would be expected to step in and provide ample liquidity in order to
jump start transactions again. Moreover, it is imperative to reiterate
that the market is now the dominant component in the Markets, Economy,
and Life (MEL) complex adaptive system, which means that a market freeze
could soon develop into an economic freeze.
So, if events unravel, what is the definition of ample when the Fed
is already pumping $110 billion into the banking system every month?
Is the answer $500 billion? $600 billion? A $trillion? More to the
point; over what period of time should the liquidity be infused: three
days, two hours, five minutes? What is the whatever it takes point
Even more pressing is the notion that with the Fed pumping $110 billion
into the financial system every month along with its promise to keep
doing so indefinitely, then why are bond yields rising as the dollar
seems to be bottoming out? I discuss this in detail below.
Buy the Dip or Take Profits? Leidos Sets up Test of Key Support
One thing is for sure, there are other stocks to consider aside from
Game Stop. For example, even as the defense sector has struggled for
the past twelve months, software and engineering firm Leidos Holdings
(LDOS) has been moving steadily higher since it bottomed out in October
2020. Sure, it weakened a bit in the last few days as the market’s
worries have increased, but there is nothing specific about this company
that is known that would account for a reason to sell the stock aggressively.
Of interest is the fact that Leidos’ business is as enigmatic as
are sectors in which it does business: defense, national security,
and civil government contracts with a sprinkling of healthcare IT,
including contracts with the Center for Medicare and Medicaid (CMS).
But perhaps what it is best known for is its national security software
and defense contracts with the Army and the Airforce. And to be honest,
no one knows what those entail due to national security issues. The
company certainly hints at some potential uses such as data gathering
and critical decision making, but beyond that we don’t know too many
details beyond the fact that Leidos makes big bucks from the U.S. government.
What is not shrouded in secrecy is the fact that Leidos has tendency
to beat earnings expectations on its earnings on a regular basis, such
as the last seven quarters. Moreover, its key metric is its contract
backlog, which as of the last earnings call stood at over $30 billion.
The company’s next earnings report is due on February 23, 2021, which
means that the market has plenty of time to anticipate the results,
which according to management were likely to be positive. Obviously,
the odds of a beat are above average, given the company’s record. Yet,
in an uncertain market, it’s not a bad idea to keep a close eye on
the shares and keep a sell stop some 5-8% under recent highs.
Still, given the market’s recent volatility even a stock which had
been in a steady uptrend such as Leidos showed some weakness on 1/29/21.
In fact, the previously robust Accumulation/Distribution (ADI) and
On Balance Volume (OBV), rolled over, which raises the question of
whether the 50-day moving average is still good support. We will know
I own LDOS as of this writing.
Market Breadth Reverses. Nears Sell Signal.
The New York Stock Exchange Advance Decline line (NYAD) reversed
its prior week’s fledgling positive divergence and ended up with what
may turn out to be an all-out Duarte 50-50 Sell signal as the RSI closed
below the 50 level and NYAD itself closed below its 20-day moving average
and looks set to test the support of its 50-day line.
So now we wait to see if NYAD remains above its 50-day moving average
on any pullback. If the 50-day is broken decisively the next test would
be the 200-day.
For its part, the S & P 500 (SPX) also delivered a nasty reversal
and closed the week just at its 50-day moving average, which means
that a major test of the uptrend is now unfolding.
The Nasdaq 100 index (NDX), which as I noted last week was over extended
with two consecutive closings above its upper Bollinger Band (upper
green line surrounding prices), became more over extended by delivering
two more closes above the bands early in the week before delivering
an aggressive reversal, with likely tests of its 20 and 50-day moving
And here is where it gets interesting. When there is stock market
trouble, bond yields usually fall as investors move to the safety of
Treasury bond. Yet, as the GameStop short squeeze hype developed, bond
yields which had been heading lower, bounced back and are testing key
resistance. This is of concern as the Fed’s current pace of T-Bond
purchases doesn’t seem to be enough to keep a lid on yields. So, if
the U.S. Ten-year note (TNX) can pull above 1.10% and make its way
through the 1.2% area, the bond bear market will be well established
and its effect on the stock market will be noticeable.
Finally, the U.S. Dollar Index (USD) has been quietly trading above
$90 for the past few weeks. This is a long-term support level, from
which long term dollar rallies often launch. It is not a coincidence
that bond yields and the dollar have bottomed close to each other.
In fact, rising bond yields are usually a driver for a rising dollar.
So, what’s my point? If traders are dumping bonds and buying dollars
it could mean that really big money is starting to bet on rising interest
rates, which means that the Fed’s long term plans to keep interest
rates near zero for the foreseeable future are being questioned by
the market and something will have to give.
Have you thought about where to invest if bond yields rise? Find
out with a Free Trial to my service. Click here .
This in no Time to Be Complacent
Is a bear market coming? I sure as heck don’t know, but it feels
as if things are suddenly different in the financial world.
For the past few months, I have written about how the bull market
in stocks is intact because the Fed’s QE has kept the bulls in control.
But I have also noted that caution is warranted.
Just last week, referring to my frequent statements about the Fed
and the market I wrote: “Indeed, just the fact that I write this type
of statement every week now is worrisome in and of itself.” In fact,
I added “no matter how much anyone worries, stocks find another up
leg as the insatiable dip buyers materialize. It can’t last forever,
but there is little evidence that it will end anytime soon. And when
it does, I hope the market shows reliable signs of such an event ahead
of it happening.”
Well, given the current signs, the market is signaling that a meaningful
correction may be unfolding. And yes, it is just as plausible that
the Fed will find a way to once again juice stocks by increasing its
QE. However, if the Fed tries a more of the same approach, even on
steroids, and it fails, we may see some very negative situations develop.
Thankfully, from a strategic standpoint, many of the stocks in our
model portfolio have already been stopped out, thus raising our cash
levels. Our recently added hedges are acting well. And as usual, when
the market falls meaningfully, I take the opportunity to make a shopping
list. So now, we wait and see what happens next.
For more on how to deal with the current market checkout my latest
Your Daily Five video here .
For more details on bonds, currencies, and stocks check out my recent
interview with Wall Street Reporter.com 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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