Analysis, Perspective, Trading Strategy
At the Edge of Chaos: The Fed is in a Cage Match with the Bond Market and there is no Escape
Duarte in the Money Options
The Federal Reserve is clenched in a cage match with the bond market
from which there is no escape for them or for the markets. Point in
fact were the technical sell signals in the major indices and the increasing
weakness in the market’s breadth as I detail below.
Indeed, the strange relationship between rising bond yields and rising
stock prices may have finally been broken returning the markets to
the traditional entanglement where rising bond yields are a negative
for stocks. Still, despite the short term pull back in yields, the
long-term trend for bond yields remains up and the stock market, although
weakened, is still not completely in sell territory, although that
could change in a hurry.
So, what’s the bottom line? The Fed is either going to have to step
up its bond buying to lower rates, or they will be forced to raise
interest rates in order to slow the stealth inflationary pressures
that are apparent in the real world, as in grocery and gasoline prices.
Certainly, given the drop in yields over the last two trading days
last week, the central banks might have already fired their initial
Unfortunately, unless something dramatic happens, such as an overnight
and massive recession materializing, it’s a no-win situation for the
Fed and for the markets; for increasing bond purchases will require
an increase in QE and will be seen as fanning inflation. Meanwhile
raising rates after promising that they won’t do so until 2023 makes
the Fed an unreliable partner to the markets potentially causing a
major debacle in stocks.
More Messy Markets Likely Ahead
Last week while describing the relationship between bond yields and
stocks I noted: “what happens in the next few days and weeks may well
define what happens over the next few months in this important and
newly redefined intermarket relationship. Stay tuned.”
Furthermore, I wrote: “the rising trend in yields may be nearing
a period of consolidation. We may even see a dip below the now important
support levels – that were once resistance. But it remains to be seen
whether this simultaneous uptrend in bond yields and stocks can be
deterred without intervention from the Federal Reserve.”
I also sounded a note of caution about the stock market, noting:
“this is a highly unnatural market relationship which means that although
we are trading it on the long side, we should not trust it. What I’m
saying is that even as the market may make new highs from here as bond
money moves into stocks, the odds of a correction in stocks are likely
to rise as this strange phenomenon continues. It’s more of a matter
of when than if.”
In fact, what happened on Wednesday, Thursday and Friday of last
week suggests that the stock and bond markets came to the same conclusion.
This was especially noticeable in the relationship between the U.S.
Ten Year Note yield (TNX) and the homebuilder stocks. Here is a summary:
- Fed chief Powell in his testimony to Congress continued to voice
his doubts about the economic recovery and inflation on Wednesday
- As Powell spoke the U.S. Ten Year note yield (TNX) retraced the
intraday yield highs it had made above the 1.40% early in the day
closing below this key chart point
- Along with Powell’s testimony home sales made
new highs on Wednesday but new mortgage applications crashed
simultaneously suggesting housing activity may have topped
- This was confirmed when pending
home sales were down on Thursday
- And after a huge rally in stocks on 2/24 rising bond yields finally
exploded above 1.5% and brought down stocks
- Finally, by week’s end, bond yields retreated suggesting that
the Fed might have intervened but few stocks were able to recover
Indeed, what that sequence of events told us is that the 1.4-15%
area on TNX is the line in the sand for stock traders. Moreover, it
suggests that bond yields may have now reached the point at which the
housing market is starting to feel the negative effects as 30-year
mortgage rates were in the 3% range and are likely to climb in the
next few weeks barring something dramatic from the Fed.
Meanwhile Fed Chairman Powell continued to signal that the Fed’s
easy money QE policy is not likely to change until 2023. So, the real
question is what will happen if and when the inflation in real life
begins to accelerate beyond the point in which the Fed can’t cite its
own inflation measures, which do not account for many real-life prices
such as those for buying (not renting) a home and food prices as the
reason for continuing QE.
And in case anyone doubts it, the spell has been broken as rising
bond yields are now doing what they were designed to do, cause stock
traders to sell as they consider moving money back into bonds. The
problem is that bond yields may still have a way to go to the upside
before it’s a good idea to buy into the bond market.
In addition, the inverse relationship between stocks and bond yields
is very much alive regarding the housing stocks as we can see in the
chart relating TNX to homebuilder DR Horton (DHI, upper linear graph).
Notice DHI’s long consolidation as TNX rose. Also notice that as TNX
pulled back inside the upper Bollinger Band DHI shares began to nudge
Have you thought about where to invest as bond yields fluctuate?
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Applied Industrial Technologies: A Cyclical Diamond in the
Rough for a Post COVID World
he market’s leadership has changed of late in response to rising
bond yields. And not withstanding last week’s bond market volatility,
the premise that shares of smaller stocks in the industrial complex
may still benefit from an economic recovery remains viable until proven
otherwise. As a result, it makes sense to examine engineering materials
and solutions company Applied Industrial Technologies (AIT); a $3.4
billion market cap company which is quietly gaining a nice foothold
in a market that is betting on an economic recovery.
As is the case with many small to midsize industrial companies, AIT
is not a household name. However, its business is becoming increasingly
crucial as the Post COVID dynamic evolves.
First, it’s important to understand how ATI fits into the so called
“recovery.” And to do so we must look at its product mix, which ranges
from fluid control systems and robotic systems repair and installation
to seemingly mundane things like hoses. Sure, not the sexiest of things;
unless you’re trying to manufacture vaccines or repair the frozen motor
or valves in your recently frozen wind turbines or oil and natural
In fact, as the company stated in its most recent earnings call,
it’s noting an increase in demand for its services in key industrial
areas such as chemicals, aggregates, paper, lumber and energy. All
of these are signs that the industrial and manufacturing sector is
starting to awaken, at least in the U.S.
Moreover, although the company’s sales have not turned positive year
over year yet since the start of the pandemic, its free cash flow,
net income, and market share are all positive year over year. Even
better is the fact that the company is starting to see increasing demand
for its businesses in the 5G, vaccine production, and robotics business.
The price chart certainly tells a compelling story as the stock recently
broke out of an extended base on big volume, which confirms the positive
Accumulation Distribution (ADI) and On Balance Volume (OBV). Furthermore,
there is very little price resistance above the breakout point as illustrated
by the Volume by Price (VBP) indicator.
Indeed, from this vantage point, it looks as if AIT is joining the
ranks of industrial and engineering companies whose futures are improving
as the world looks to emerge from the COVID nightmare. Finally, in
the current market it makes sense to see how the shares fare in response
to the evolving volatility. However, as long as AIT remains above its
50-day moving average it is worth considering.
I own AIT as of this writing. For more stocks like AIT consider a
FREE trial to Joe Duarte in the Money Options.com. Click here .
Market Breadth Nears Sell Signal and Major Indexes Deliver
Short Term Breakdown
The New York Stock Exchange Advance Decline line (NYAD) almost delivered
a new high on 2/24/21 but failed in the attempt just one day before
the dam burst on bond yields. This is clearly a sign of weakness for
the uptrend. Therefore, caution is warranted.
What that means is that we now have to pay
special attention to key NYAD chart points in order to see what comes
next. Specifically, consider that as long as NYAD continues to make
new highs, remains above its 50- and 200-day moving averages and
its corresponding RSI reading remains above 50, the trend is up.
This combined set of observations has been extremely reliable since
That said, the way things ended last week leaves us in limbo as RSI
closed right at 50 and NYAD crashed through its 20 day but not its
50-day moving average. The most recent two similar situations resolved
to the upside but patience is a virtue here.
For their part, the S & P 500 (SPX) and the Nasdaq
100 (NDX) rolled over midweek, in response to the volatility in the
bond market. Moreover, NDX broke below its 50-day moving average and
is near the 30 area on RSI, which would make it oversold. SPX, remained
above its 50-day moving average but is also trading below 50 on RSI.
The bottom line, though, is that if this pullback
is similar to recent pullbacks, because of the aggressive selling
in the indices, much of the selling may be nearing its conclusion.
If this is true, then the RSI 50 area for NYAD will provide support
and the uptrend will resume. A failure of the NYAD would confirm
the sell signal in NDX and likely lead to further selling for the
Next Move in Stocks is Anyone’s Guess
The volatility in bond yields seems to be creating confusion in the
stock market, which means that trading may be difficult in the next
few weeks as things sort out. That said, in a market ruled by artificial
intelligence algos and still fueled by QE from global central banks
the current confusion may be over as quickly as it started.
In other words, the best way to manage this market is to stick with
sound trading rules and watch each individual position as it relates
to the general trend in the market.
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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