The Fed Promises Lower Rates. The Algos Leap for Joy. 
  Enjoy the Show.

August 25, 2024

The Fed is on the verge of a slow and steady interest cutting cycle and the biggest beneficiaries, outside of the usual suspects (tech stocks), are likely to be the homebuilders, the REITs, and the infrastructure sectors.

I recently wrote: “The bulls are back in charge, in the short and the intermediate term, until proven otherwise.  Inside the market, as I describe below, the big news is the recovery in large cap tech. Yet, of equal importance is the stable performance in housing and REITs, and most of all, the stealthy momentum run in the utilities.”

More recently, I suggested that Fed Chairman Powell’s Jackson Hole, Wyoming comments would be the key to what happens next in the stock market, especially in the housing market.

So far so good.  Now it gets interesting.

NYAD Again Proves Its Worth

Over the last few weeks, I’ve noted that even though the major indexes have suffered some setbacks, the New York Stock Exchange Advance Decline line (NYAD, see below for full details) has remained very calm. This type of action usually indicates that the market is in a consolidation/rotation trading pattern where profit taking and redeployment of money, not outright abandonment of the market (what happens in a bear market), is the most likely outcome.

And that’s exactly what we’ve seen, money moved out of the overextended technology sector, especially the AI stocks, and has been quietly moving into other areas of the market where valuations are more attractive.  That doesn’t mean tech stocks are dead. In fact, the recent pullback has given them room to rise once again.

At the end of the day, what matters is the level of liquidity, and the order flow – which right now is positive, and could improve further once the Fed starts the easing cycle. That’s because the machines (algos) wipe the slate clean at the market’s close, and start the new day fresh.  Buy orders trigger more buying, and sell orders trip more selling.  And when the Fed says it’s going to lower rates, that usually prompts the machines to open up the liquidity spigot, as the buy orders rise.

Of course, everything could change in an instant, as we saw just two short weeks ago when the Yen carry trade unwound triggered heavy selling.  On the other hand, I  don’t want to rain on anyone’s parade.  So, enjoy the show.

But trade cautiously because in a world of machines, every day is a new day – and well, it is an election year, so anything is possible.

QQQ Holds Back After Powell Comments

The Invesco QQQ Trust (QQQ) remains an excellent way to keep tabs on what the big money is doing.  And, as I always say, following the big money is often a great way to make successful trades.

Thus, its response to Fed Chair Powell’s bullish comments is worth noting.  Interestingly, but not surprisingly, QQQ joined the rally but did not break out of what could be an extended trading range.

This lack of action suggests that money is still cautious about big tech.  Note the ADI (short sellers) and OBV lines (buyers) are moving sideways.  On the other hand, the RSI is hovering near 50, which means that after the consolidation, QQQ has room to rise.

So, follow the money and trade one position at a time:

• Always expect the unexpected;
• Stick with what’s working – if any position holds up, keep it;
• If you get stopped out, move into strength;
• Let the price charts do the talking; and as always;
• Don’t fight the tape!

Home Depot Suggests Market Bets on Housing

There are some companies which are excellent bellwethers for the market’s bets on the economy. One of them is Home Depot (HD), whose shares offer a glimpse into the status of the housing market via the lens of whether consumers are willing to fix their homes. 

There are two important factors to glean. One is whether homeowners are willing to spend money on repairs for their homes. The other is whether the homeowner is fixing up the house to stay in it, or more importantly for the housing market, to sell it.

What makes the action in HD interesting these days is that the company just offered negative guidance on its most recent earnings report, citing a slowing consumer.  Yet, the shares are holding up. Moreover, they look poised to move higher after Jerome Powell’s pivot toward lower interest rates.

What’s my point? Wall Street is betting on at least a targeted – home improvement based - consumer resurgence as interest rates fall.  In addition, and given the action in the homebuilder and REIT stocks, they may be betting on an increase in the number of houses for sale; which of course would mean more repair work on potential houses to be sold.

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Housing Breaks Out on Powell Comments and Rising New Home Sales

The U.S. Home Construction ETF (ITB) moved decidedly higher after Fed Chairman Powell’s comments on lower interest rates, issued at the Fed’s annual confab at Jackson Hole, Wyoming. What makes the move even more impressive is the rise despite recent housing market data points:

• Single family housing starts are down;
• Existing home sales are flat; and most importantly;
• New home sales beat expectations handily in July.

So, as I’ve been saying, there are fewer homes for sale.  Meanwhile, the median existing home is now 43 years old.  All of which means that in the foreseeable future, homebuilders are in the sweet spot of having limited supplies of homes available, just as the Fed is starting to ease. 

Bond Yields and Mortgages Hug Recent Bottoms

The U.S. Ten Year note yield (TNX) remains in a bullish consolidation pattern, holding below 4%. And while this is bullish for stocks in general, the Fed’s recent bullish pivot toward lower rates makes it a very bullish development for the housing market; which accounts for 16% of GDP.

Mortgage rates are in bullish territory as well, below 7% for the twelfth straight week.  Moreover, they remained below 6.5% for 30-year conventional loans.  I’ll be watching for an increase in activity on the ground.

In addition, the real estate investment trusts (REITs) retained their bullish tone as they usually do when interest rates are in bull markets.  The iShares U.S. Real Estate Market ETF (IYR) is holding near its recent highs. Look for sideways action here, not a decline.

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AD Line Makes New Highs – No Sign of Bear Market is Visible.

The New York Stock Exchange Advance Decline line (NYAD) made several new highs last week. And although it may pause in the short term, if there is no breakdown in the indicator, the all-clear signal remains intact.

The Nasdaq 100 Index (NDX) is testing the support of 50-day moving average. We may see some further consolidation here. A move above 20,000 would confirm a continuation of the uptrend.

The S&P 500 (SPX) is within reach of a breakout, with the 5675-5700 area offering some resistance.  Money is steadily flowing back into the market as both the ADI (short covering) and OBV lines (buyers coming in) are rising.

VIX Recovers After Blowout

The CBOE Volatility Index (VIX), consolidating between 15 and 16.  A bit of sideways action here would be very comforting.

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.

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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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