Joe Duarte’s Smart Money Trading Strategy Weekly

By Joe Duarte Editor Joe Duarte in the Money Options

The Fed Talked. The Market Reacted. Think Value.

December 17, 2023

Yogi Berra once said: “It was impossible to get a conversation going, everybody was talking too much.”

It’s easy to lose one’s focus when everyone is talking, especially after big moves in the markets and the uncertainty they often create.  But instead of getting rattled, focus on a simple principle; value never goes out of style.  So, while some may fret about the present and forecast the future, wise investors seek out those areas of the markets which are likely to be the next leaders and trade accordingly.

Value Never Goes Out of Style.

After the Fed’s recent bullish reversal on interest rates bonds and stocks rallied dramatically. Both markets have come a long way in a short period of time and need a break.  Thus, as many investors worry about the future, the patient ones who identify those sectors of the market where value is building, as I describe below, are likely to eventually be rewarded. 

Fed Chairman Powell, during his post FOMC meeting press conference in 12/13 noted that rate hikes have paused and further hinted that the central bank is now “talking” about rate cuts.  Both bonds and stocks erupted in gleeful accelerations of their recent rally.  But, by 12/15, New York Fed president Williams said the Fed isn’t really talking about rate cuts.  His remarks lead to a reversal of the pre-market futures which spread into a much calmer trading day.

Stay Calm

This public disagreement between two big guys at the Fed is par for the course.  Likely, the huge move in the markets spooked the central bank which is desperately trying to engineer a soft landing – where the economy slows enough to quell inflation without a recession.

Soft landings are rare.  In the past fifty years, the Fed has only pulled off one; think Alan Greenspan in 1994.

The bottom line is that the markets are trying to sort out what to do next and what the most recent actions from the Fed mean, which means that after the huge rally in stocks and bond, trading is likely to get choppy.  The upside is that, as I described in my latest Your Daily Five video, choppy markets are ripe for bargain hunters and value players.

So, while we wait for the next big move, here are four simple steps to take:

• Stick with what’s working; if a position is holding up – keep it;
• Take profits in overextended sectors;
• Consider some short term hedges; and
• Look for value in out of favor areas of the market that are showing signs of life.

Bond Yields Crashed Taking Mortgages Below 7%.

The U.S. Ten Year Note yield (TNX) crashed on the bullish news from the Fed and ended last week below the key 4% area, which I’ve noted as being a crucial support level.  The long term implications of this are generally bullish, but investors should review the response to the fall in yields in each individual sector of the market and in positions in their portfolio before making decisions.

For example, the Fed’s actions were initially bullish for the homebuilder sector (SPHB), which rocketed to a new high on the news.  But the homebuilders have come quite far in a short period of time since I recommended them back in late September,  so they are well due for a consolidation.   On the other hand, given the break in mortgage rates below 7%, the odds of more than a moderate pullback in homebuilder stocks is low, until proven otherwise.  Meanwhile, a test of the 6.8% level for the average mortgage is looming.

REITs, like homebuilders have rallied recently.  The iShares Residential Real Estate Capped ETF (REZ) may have formed a short term top, as investors worry about a reduction in renters as lower mortgage rates influence potential renters to buy homes.  Still, until proven otherwise the supply and demand scenario remains in favor of homebuilders and specialists in residential rentals who can deliver the best product for the best price to potential renters and homebuyers.

For the big picture on homebuilder and real estate stocks click here.  

Stay Patient.  Look for Value.

Last week in this space I noted that because of the Fed’s meeting and the release of inflation data on the same week it made sense “to review portfolios carefully, to consider taking some profits and to game out some potential ways to hedge,” while adding that the Nasdaq 100 Index (NDX) was forecasting a large, and potentially bullish move soon.”

Let’s catch up. The Invesco QQQ Trust (QQQ), has been a money magnet since the October bottom. Yet, its rate of rise has slowed since the Fed’s pivot.  Much of it has to do with the consolidation in Microsoft (MSFT), whose shares are under selling pressure as you can see by the rolling over in its OBV line and the stock’s break below its 20-day moving average.  But don’t count the surprisingly diversified QQQ out just yet. Both the ADI and OBV line are rising as money is still moving in.

Microsoft’s short term stall suggests that investors are looking elsewhere and that money is once again rotating away from the AI vibe.  Yet QQQ’s rising ADI and OBV line indicate money is rotating to other areas.  Surprisingly, building material and metal stocks are still acting well, as the market is considering another up leg in infrastructure projects.

You can see positive money flows and the relative strength in the Materials Select Sector SPDR Fund (XLB). Note the bullish rise in Accumulation/Distribution (ADI) and On Balance Volume (OBV) for XLB especially in comparison to Microsoft, where both have rolled over as short sellers build positions (ADI) and sellers are starting to overwhelm buyers (OBV).

Look at global shipping. Due to the situation in the Middle East and the severe drought affecting the Panama Canal, this area of the market is offering patient, value oriented investors an opportunity.  The action in the little known and thinly traded Global Sea to Sky Cargo ETF (SEA) suggests that stealth money is building a home in the sector.  Both ADI and OBV are turning up here.  I recently recommended a shipping stock which is showing excellent characteristics.  You can check it out with a FREE two week trial to my service here.

Market Breadth Retains Upward Bias.

The NYSE Advance Decline line (NYAD) is both overbought and in a bullish trend, trading above its 50 and 200-day moving averages.  The recent rally is likely to trigger some sideways movement here.  A move back to the 20-day moving average is not out of the question. 

The Nasdaq 100 Index (NDX) is above 16,000 as the Fed’s bullish talk squeezed short sellers.  NDX is now trading outside its upper Bollinger Band suggesting that a short term correction or consolidation is near. Both ADI and OBV are rising, so the overbought condition could increase before any consolidation.

The S&P 500 (SPX) rallied above 4600 thanks to the Fed.  SPX, as RSI is well above 70. A consolidation and perhaps a move back to the 20-day moving average should be expected.

VIX Remains Below 20

The CBOE Volatility Index (VIX) is 20, a bullish posture for stocks.  If VIX remains subdued more upside is possible.

A rising VIX means traders are buying large volumes of put options.  Rising put option volume from leads market makers to sell stock index futures to hedge their risk.  A fall in VIX is bullish as it means less put option buying, and it eventually leads to call buying which causes market makers to hedge by buying stock index futures raising the odds of higher stock prices.

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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 selling Trading 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.

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