Joe Duarte’s Smart Money Trading Strategy Weekly

By Joe Duarte Editor Joe Duarte in the Money Options

The Tail That Wags the Economic Dog is the Stock Market.  How the Markets Now Lead Economies.

April 7, 2024

Last week was puzzling.  The Fed threw cold water on rate cuts, calling for one rate to maybe none.  Chairman Powell stuck to the middle.  Wall Street had a real life earthquake ahead of the highly hyped total solar eclipse scheduled for Monday, followed by CPI and PPI.

What could possibly go wrong in the Latest New Normal?

Sometimes it’s hard to see the obvious.  So, if you’re looking for a why we’re not in a recession, look to the stock market, which continues to rumble higher; albeit in fits and starts.  Of course, given the global geopolitical situation and the levels of government debt that are accruing, the doom and gloom crowd may eventually be proven to be correct - just, not last week – except on Thursday.

My recent poll on the economy showed that 62% of responders were not worried about the economy.   They agree with the government’s data, which suggest the jobs market is perking right along and the economy is “resilient.”  Of course, the fine print in last week’s employment data shows that not all is as well as the headlines suggest.  That’s because layoffs seem to be increasing (Apple just furloughed 600 employees) and there are suggestions that perhaps many of the new jobs being created are part time jobs.

But, it could be worse, as the markets, which are run by algos ignore the fine print and may be adjusting to a new normal vibe.  It’s hard to know how accurate the fine print because it’s full of estimates and is prone to revision.

Therefore, I focus on the markets, and how they respond to the data.  And what I’ve noted over the last few years, is that the markets are much more important to the economy than many realize.  Here’s why.

Why Markets Now Lead the Economy – A Review of the M.E.L.A. System

The prevailing view in traditional economic circles, including the Fed, Is that economic activity precedes the action in the markets.  Yet, since the pandemic, this relationship is no longer reliable.

Way back in 2019, I introduced the M.E.L.A. system where M stands for Markets, E stands for Economy, L is for people’s life decisions, and A is for Artificial Intelligence (AI).  M.E.L.A. is a complex adaptive system where each participant (agent) interacts with all the other agents in the system and the environment looking for a successful outcome – emergence to the next level or payoff.  Perhaps the most important part of complex systems is that once this payoff is identified, all the participants flock to it and the activity at that place increases to the point where the system moves to a higher point of operation where the process begins anew. 

Places where the system consolidates are known as the Edge of Chaos, where Complexity (normal behavior) meets with Chaos (Disorder).  If Complexity wins, the system moves to a higher plane delivering a payoff. If Chaos wins, the system descends into Disorder until Complexity returns and normal function is restored.

If this sounds familiar, you can see this process play out in any stock chart you choose.  In price charts, uptrends are fueled by Complexity, downtrends reflect Chaos.  Support and resistance levels the boundaries of the edge of Chaos.

It’s the 401(k) That Holds it Together

For many people, wages from traditional jobs can only cover part of their living expenses. That’s because the global economy runs on debt – credit cards, loans, pay as you go.  Debt servicing sucks up capital. This is especially applicable to big purchases such as homes and cars.  To adjust, some get extra jobs – side hustles; Uber (UBER), Door Dash (DAH).

Moreover, the pandemic exaggerated the situation tipping the balance toward the markets as a primary source of income. Many became professional traders.  Many have remained in the profession, full or part time to gain extra income or to pad their financial resume’.

As a result, many use the value of their 401(k) plans and IRAs as sources of income to qualify for loans and as collateral for big purchases.  Banks are more prone to lend to anyone who has a well-paying job, and a solid retirement plan. 

Putting it All Together

Here’s how it works.  When stocks rise, the value of retirement plans rises, increasing the owner’s wealth; albeit only on paper.  Increased paper wealth makes it possible for the owner to qualify for loans and spend money.  Thus, contrary to traditional dogma, bull markets fuel the economy, while bear markets lead to economic decline.

When the stock market rises (M), people feel better and spend more money (E).  Their spending fuels their life decisions (L – vacations, new homes, new cars).  Artificial Intelligence (A) magnifies the market moves, triggers bullish loan algos, and the message spreads like wildfire via social media amplifying the magnitude of the process.  The system emerges and everyone chases the payoff further increasing the bullish effect on the economy.

And while I’m all for feeling wealthier as stocks rise, I never forget these sound trading principles.

• Expect an Increase in Volatility.
• Stick with what’s working; if a position is holding up – keep it;
• Take profits in overextended sectors;
• Consider some short term hedges;
• Look for value in out of favor areas of the market;
• Protect your gains with sell stops. Raise them as prices of your holdings rise;
• Trade one day at a time; and
• Keep an eye on Bitcoin

What’s the bottom line? Bull markets fuel positive economic data by juicing up the value of paper assets such as retirement plans and paper wealth.  You can take that to the bank.

Bond Yields Survive Jobs Report Ahead of CPI

The bond market did not take out the important 4.4% yield area for the U.S. Ten Year note (TNX) despite a boffo employment reports.  Now we wait and see what CPI and PPI do next week.

As I’ve recently noted, a move below 4% or above 4.4% will set the stage for the next trend – up or down.  Vote your expectations for CPI here.

No matter what, I have a solution for inflation and your wallet.  Grab a paycheck via actively trading stocks, via my active trader focused Substack page here.  New trades are posted on Mondays.

Big Oil Surges as Homebuilders Hold Their Own

Brent Crude Oil breached the $90 per barrel price level last week.  Meanwhile, money continued to flow aggressively into the oil stocks.  The Energy Select SPDR Fund continued its climb fueled by fears of supply problems stemming from a worsening of the situation in the Middle East.

The S&P SPDR Homebuilders ETF (XHB) continued its recent consolidation after making new highs the prior week.  XHB’s uptrend has been fueled by the climate of market timing in the housing sector in which buyers and sellers wait for dips in mortgage and then flood the market during favorable periods.

Mortgage rates near 7% usually slow the activity. But once they start to pull away, the timers kick the activity into high gear.  Check out my latest homebuilder and energy picks with a Free Two Week trial to my service, here. 

NYAD Remains in Uptrend.  NDX Cools Off. SPX Holds Steady.

The NYSE Advance Decline line (NYAD) remains in a bullish up trend.  NYAD has worked off its overbought status (RSI below 70) while holding at the support of its 20-day moving average. 

The Nasdaq 100 Index (NDX) remains range bound but both the ADI and OBV lines are slightly cautionary as the index tests its 50-day moving average.  The index is still trading between !7500-18000.

The S&P 500 (SPX) broke below its 20-day moving average and may still tag the 50-day moving average, and perhaps the 5000 area.  ADI is rolling over (short sellers moving in) while OBV is less steady (buyers are pulling back).

VIX Creeps Above 15.  Put/Call Ratio Surges then Falls.

The CBOE Volatility Index (VIX), moved above 15, a sign that bears are making a move. If VIX continues to climb expect more volatility in stocks.  A sustained move in VIX above 15 will turn things increasingly bearish.

The CBOE Put/Call ratio ended the week on a down note, but remained above 1.0.  When the put/call ratio and VIX rise together, it usually means that volatility is on the rise.

VIX rises when traders buy large volumes of put options.  Rising put option volume leads market makers to sell stock index futures to hedge their risk and leads markets lower.  A fall in VIX is bullish signaling lower put option volume, eventually leads to call buying which is bullish as it causes market makers to buy stock index futures raising the odds of higher stock prices.

To get the latest up to date information on options trading, check out “Options Trading for Dummies”, now in its 4^th Edition – Available Now!

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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.

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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