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October Surprises Pile On. Hurricanes, Butterflies and Consequences.

October 13, 2024

There are two major tenets which anchor Chaos Theory.  One is that, based on the dot plot of the original equations by its creator, Dr. Edward Lorenz, resemble a hurricane.  The second is the principle of the Butterfly Effect, where the flapping of a butterfly’s wings in a distant region of the world can cause hurricanes elsewhere – directly or metaphorically.

The Hurricanes

October surprises keep rolling in with two major hurricanes, sticky inflation data, and at least one Fed president (Bostic) suggesting that the central bank may skip a rate cut at its upcoming November meeting. Meanwhile, New Zealand’s central bank cut rates by 50 basis points and promised more cuts, while the PBOC’s “Bazooka” stimulus may have already run its course.

All of which adds up to large parts of the global economy slowing down while inflation is becoming structural.   And aside from all the personal struggles which hurricanes Helene, and Milton have caused, the long term effects of the destruction they have sown will likely be felt for months to years depending on the extent of the damage caused.   Moreover, the effects are likely to be economic, political, and could conceivably affect, and perhaps to some degree affect the population migration to the Southeast U.S. 

The Butterfly Effect

Over the last few days, I’ve seen a handful of Monarch butterflies on their way South.  I’m glad to see they are not extinct as some have been forecasting for years.  When I woke up this morning and went outside, I saw a new car parked in a neighbor’s driveway.  The license plate was from Florida.   Perhaps I’m being dramatic, but it seems as if the butterfly effect is on full throttle.

Perhaps the most important economic aspect of this Chaotic set of events is how all the destruction and potential displacement will play out in a world where supply chains are strained and inflation is stubbornly hanging on. 

One final thought on Chaos.  It is predictably unpredictable, which means that its effects will unfold on their own timeline. 

There are no coincidences, just events.

Inflation is Becoming Structural

Two weeks ago, it was all about the September employment report delivering more new jobs than expected.  Last week we saw rising jobless claims, stronger than expected consumer inflation and flat producer prices just as the dock strike was averted until January 2025.  In my daily life, I’m not seeing any respite on inflation as my weekly trek to Costco offered me the opportunity to pay $2 more for the same number of avocados and $4 more for beef flank steaks compared to the prior week.  To be fair, prices on other items which I buy regularly remained the same, except for eggs, which are up $.50 per two dozen since February 2024.

Indeed, inflation is becoming structural, which means that even though prices may flatten out, or even decrease to some degree, the already present increase in prices isn’t likely to recede anytime soon.   As a result, markets will respond, especially in bond land where traders are worried that global central bank rate cuts will increase money supply and liquidity in a setting where there is already too much money chasing too few goods leading to a rekindling of inflation.

U.S. Ten Year Note Yield Support Level is Now 4%.  Mortgages May Have Bottomed Out

The U.S. Ten Year Note Yield (TNX) continues to carve a new path, with yields rising above 4%, which is now becoming a support level, which may prove quite stubborn.    

On the other hand, given the relatively benign reading in the PPI, and the overbought state of TNX, with its RSI above 70, we could see a retracement which could move back to 3.8%.  But such a retracement would likely require a sudden set of developments in geopolitics or a surprise in new data such as retail sales, which are due out next week.

For their part, mortgage rates have bottomed out, which has killed the refinancing boom for now.  What remains to be seen is whether the move off the bottom will spur potential buyers who expect rates to move even higher to take the plunge into a home purchase or whether they opt to rent as the potential mortgage payment on a new home would be outside of their budget.

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Homebuilders Remain Stable.  REITs Search for Support.

I remain patient on the homebuilder sector.  As I’ve said over the last few months, supply and demand are on their side.  Moreover, the unfortunate results of hurricanes Helene and Milton will play a role in what happens in this sector next.  As the Southeast U.S. rebuilds, homebuilders will likely see an increase in demand for their services, both in the affected areas, and perhaps in other areas of the country as some of those affected by the hurricanes may choose to leave. 

The iShares U.S. Homebuilding ETF (ITB) remains in a consolidation pattern but well above its 50-day moving average. Moreover, the Bollinger Bands are squeezing prices, which usually precedes a big move. That means the intermediate term uptrend is intact.  The 50-day moving average has been an excellent place to buy dips in ITB since it turned around in July.

The iShares U.S. Real Estate ETF is still testing its 50-day moving average.  This sector has been more sensitive to interest rates than the homebuilders.  Thus, much of what happens here will depend on what happens in the bond market.

Again, it’s worth noting that housing is a physical asset and that physical assets are traditionally seen as inflation hedges. 

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Focusing on the Post Hurricane Rebuilding Theme

The two major hurricanes that hit the Southeast U.S. are likely to affect the demand for building products while providing challenges to the supply chain.  One sector which seems poised to benefit is building materials, in terms of repairs to the electric grid and road damage, but also in the form of increased demand for building materials.

The Utilities Select Sector SPDR Fund (XLU) is struggling due to the rise in bond yields, combined with the likelihood of increasing expenses to rebuild and repair infrastructure in hurricane affected areas.  XLU looks set to move back above its 20-day moving average, though, which has been a great place to add to positions on most dips since February.

The Invesco Dynamic Building and Construction ETF (PKB) is closing in on a breakout. A move above $80 could take this ETF significantly higher.   

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AD Line Flexes its Muscles

The New York Stock Exchange Advance Decline line (NYAD) found support at its 20-day moving average after working off its recent overbought reading.  The uptrend is reasserting itself, but we need to see a confirmation of the new high on SPX with a new high on NYAD.

The Nasdaq 100 Index (NDX) is setting up for a move above the 19,500-20,000 trading range, with 20,750 being an important resistance level.

The S&P 500 (SPX) made a series of new highs last week.  The 20-day moving average continues to be a viable re-entry level.

VIX Calms Down

The CBOE Volatility Index (VIX), rolled over but remains above 20. A further move below 20 would be a positive.

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.

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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