Joe Duarte’s Smart Money Trading Strategy Weekly

By Joe Duarte Editor Joe Duarte in the Money Options

While the Fed Grabbed the Headlines, SPX Crept up on 5000. What Happens Next?

February 4, 2024

What a strange trading week it was.  While investors fretted about the Fed, the S&P 500 was sneaking up on the landmark 5000 price point.  When the index hits that vaunted round number, it will likely trigger significant trading programs.  Whichever way they move will affect what happens in the markets and the economy.

It’s a good time to be ready for anything.

With so many external market influences simultaneously converging, the next few weeks require focus, attention to detail and precise trading strategies.  On the other hand, adversity is often a prelude to opportunity, which means that it’s time to put on our trading hats and drill down to the most promising areas of the market.

To forecast the future is a fool’s errand.  Being prepared is the path to wisdom.  The best approach is the application of balanced, practical approach, which factors in multiple possible scenarios. 

The Big Picture

Here’s where things stand:

• The Federal Reserve won’t be lowering rates in March, unless the economy weakens significantly;
• The flip side is that the odds of a rate hike are nearly zero;
• Geopolitical issues – Ukraine, the Middle East, and their effect on the supply chain aren’t going anywhere;
• Cash remains attractive; thus, holding above average levels in accounts is sensible until the Fed lowers rates;
• The action in the bond market is highly correlated to the action in stocks; thus, monitoring the state of the U.S. Ten Year Note yield (TNX) is advisable;
• Markets can sort out pockets of strength and weakness within sectors. As a result
• Individual company shares and options still offer the best opportunities for speculative gains.

Bond Yields Bend but Don’t Break

The bond market swung wildly last week with U.S. Ten Year Note yield (TNX) falling as far as 3.8% after the Fed’s rate announcement, while retracing much of the decline after the stronger than expected jobs report, which once again disagreed with private market data released earlier in the week.  You can see a thorough analysis of what the private data is saying about the jobs market, here.

As the week closed, TNX had retraced about half of its move to 3.8%, but remained below its 200-day moving average and the 4.1% area.  This is a relatively positive development, as a move back above the 200-day moving average would suggest that bond traders are increasingly bearish and could push stock prices significantly lower.  

Of note is the fact that the S&P 500 (SPX) notched a new high despite the reversal in bond yields.

Strong Sectors

Two sectors, industrials, and retailing flexed their muscles.  Given their cyclicality, it’s difficult to match their market outperformance with the idea of a recession.

The Industrial Select Sector SPDR ETF (XLI) broke out to a new high in response to the stronger than expected payrolls number.  The Accumulation/Distribution indicator (ADI), moved decidedly higher, suggesting that short sellers are abandoning positions. Meanwhile, the OBV line broke out of its recent consolidation pattern, as real buyers joined the fray.

This unexpected move in the industrial sector is a result of bullish earnings from a major supply chain management company, WWW. Grainger (GWW).  Its blowout earnings indicate the status of the supply chain and how smart money is moving toward these companies. And while the stock’s current gains look unsustainable, its business model and the business conditions in which it has thrived are unchanged. That means there are still opportunities to capitalize in the segment.   I just added a new supply chain management company, which has been flying under the radar, which looks set to break out to my model portfolio.

The VanEck Vectors Retail ETF (RTH) added to its recent gains, and is due for a consolidation.  Much of its strength resulted from the exceptional beat of expectations by Amazon.com (AMZN), on its earnings report.  I recently recommended an option position on a retail stock, which is dovetailing on Amazon’s good fortunes.  You can check it out with a Free Two Week trial to my service, here.

Why Homebuilders Are Holding Up

Perhaps, the most interesting sector in the current market remains the homebuilders, where there are several important crosscurrents vying for influence.  For details, I recommend this post,.

The major influences on the housing market are interest rates and the state of supply.  The latter remains a positive for homebuilders, as there aren’t enough homes available to meet demand. Volatile interest rates are neutralizing the bullish tone from tight supplies.  

An underappreciated positive for homebuilder stocks, is the potential for mergers and acquisitions in publicly traded homebuilders.  Already, larger players in the sector have been gobbling up smaller privately held competitors to expand their local market shares in tight markets.  At some point, this dynamic may extend into publicly traded companies.

The net effect of current conditions is reflected in the consolidation pattern visible in the SPDR S&P Homebuilders ETF (XHB).  Still, the ETF is once again under accumulation, as both the ADI and OBV lines are rising.

A Practical and Balanced Approach

While risk management is the prime directive for investors, there are still areas of the stock market which are worth considering.  That means that portfolios should be prepared for both a rise or a fall in stocks. Keep these factors in mind.  Here’s a practical roadmap.

• Stick with what’s working; if a position is holding up – keep it; (see section on homebuilders below);
• Raise cash by reducing position size while maintaining exposure to strong stocks;
• Consider short term hedges such as put options and inverse ETFs. These could soften the blow if the Fed spooks the markets;
• To reduce risk of loss, consider trading options instead of stocks;
• Look for value in out of favor areas of the market that are showing signs of life but build positions slowly; and
• Protect your gains with sell stops and keep raising them as prices of your holdings rise;
• Finally, some level of hedging seems advisable.

If you’re looking for ideas on how to hedge against risk, my latest video offers details on the successful use of put options in real time.  Check it out here.

For details on my latest option trades and where to put your money now, consider a FREE Trial to Joe Duarte in the Money Options.com.

NDX and SPX Blast to New Highs. Market Breadth Holds Back.

The NYSE Advance Decline line (NYAD) made one new high last week, but rolled over by week’s end.  In the wake of new highs in the major indexes, this is something to keep an eye on.  On the other hand, the lag in the NYAD is easily corrected by one or two bullish days.  So for now, we’ll give the market the benefit of the doubt.

The Nasdaq 100 Index (NDX) made a new high, on the strength of bullish earnings from Amazon (AMZN) and Meta (META).    Note that the ADI and OBV lines for NDX were less robust than those for SPX. 

The S&P 500 (SPX) continued its huge upward momentum thrust, and may hit 5000. That’s when things will get interesting.

VIX Remains Below 15

The CBOE Volatility Index (VIX) logged in another week near 15. This, for now, remains a bullish factor 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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