The Markets and the Fed’s defense of it are leading the economy, explains Joe Duarte.
“Engage people with what they expect; it is what they are able to discern and confirms their projections. It settles them into predictable patterns of response, occupying their minds while you wait for the extraordinary moment — that which they cannot anticipate.” ― Sun Tzu, The Art of War
Throw out the old playbook. We are near the point of Emergence in the Markets, the Economy, and People’s Lives (MEL) as key technical indicators are pointing to an imminent upside breakout for stocks. While the mainstream investment gurus and economists search for the elusive V, L, or U shaped recoveries, beyond their radar screen an entirely different process is being shaped by the ruling force of the Universe, complexity, which acts in a purely non-linear fashion and beats to its own drum independent of anyone’s opinion.
In fact, based on price chart and trend analysis, and fueled by the Federal Reserve, we are well into a secular – long term and meaningful change in MEL, the complex adaptive system composed of the markets, the economy, and everyday people’s lives and financial decisions. Therefore, even as some are predicting a dismal outcome, investors should instead be paying close attention to the reality on the ground, not fighting the Fed or the market’s momentum and allocating their resources accordingly.
MEL’s Big Move Has Started
Covid-19 has hastened the movement in MEL toward what is known in Complexity jargon, as the point of emergence; the series of events which culminates in a decisive move which delivers systems to their next level of operation; what stock traders call a breakout. Therefore, if the current trend remains uninterrupted, I expect the combination of the ongoing pandemic, the ensuing social unrest and the rising election uncertainty to tip the balance of people’s decision making regarding where and how they live and work.
Moreover, this transition will affect how people spend their money. From a trading standpoint, it’s becoming increasingly clear where the next set of winners will materialize in the stock market.
Certainly, a currently popular view is that the highly indebted global economy won’t be able to function much longer, especially under the weight of the pandemic, and that a double-dip recession or worse will deliver long lasting economic pain.
Yet, in many places in the real world, the jury is still out on these expectations. In fact, what’s actually happening is that MEL is adapting, albeit in non-linear fashion. This means that the activity is not uniform and seems regionally uneven. Indeed, this lack of linearity is confusing to many, but in fact it is a naturally occurring phenomenon and the central concept in complexity.
Be that as it may, what is increasingly visible is that events are shaping humanity, and people are reacting. One reaction which is increasingly evident is the migration from areas of the country where life is increasingly difficult to other regions where there is more opportunity: whether it’s a move to the suburbs or a move to a totally different geographic area. In other words, the system is acting according to the tenets of complexity by adapting to the circumstances.
Of course, there are no guarantees of any particular outcome as complexity has its own agenda. Certainly not everyone is benefitting from the current situation, and it is entirely plausible that the mainstream is correct, and the world’s economy will crash and burn. Nevertheless, it is at least equally plausible, and backed by price chart analysis and emerging data, that instead of a declining economy what we are actually seeing is an increased regionalization of the population and a concomitant reshaping of economic activity.
Indeed, in this space I have frequently discussed the increasing number of out of state license plates I see on the highways as I drive to work and the generally upbeat economic activity in my hometown of Dallas. Surprisingly, I am now seeing what seems to be an increase in the number of out of state license plates, the number of U-Haul trucks from other states, and large truck traffic on the highways as I haven’t seen in years. Moreover, my business channel checks continue to provide encouraging, albeit somewhat spotty data at times.
You can certainly argue that my observations are only those of one person and that if I drove down a different highway, I might see a different picture. Yet, the migration away from big cities is now manifesting itself in tangible data. For example, the most recent housing starts and housing permits data overwhelmingly shows that the new builder focus is on single family units and away from multiple family units as demand for the former increases and demand for the latter decreases. In other words, MEL is on the move.
The Fed Has Few Options
So, what’s the bottom line? The old playbook: the economy drives the markets is no longer operational. In the present, the tail (the market) is wagging the dog (the economy).
Therefore, even as the Federal Reserve has hinted that it wants to cut back its QE programs, the odds of them actually doing so seem remote because the stock market is now the number one factor influencing MEL. Thus, if the Fed stops QE and the market crashes, it will be the market’s crash, due to the Fed’s actions that will lead to an economic crash. Now, if you’re the Fed, you know this to be true, which means that the odds of a meaningful reduction in QE, beyond what’s already in place is not likely to be in the cards.
Investors who are in tune to the changes in the markets, the economy, and people’s lives (MEL) and how this complex adaptive system works will likely fare better than those who think of the world in traditional terms. A great example is the price action of DR Horton (DHI), the largest homebuilder in the U.S., which is a perfect MEL stock.
More on the MEL/DHI connections in tomorrow’s report.
NYAD Poised for Explosive Upside Breakout
Last week in this space I noted: “the most interesting aspect of NYAD this week is the shrinking Bollinger Bands (green bands above and below the line). This is usually a sign that a big move in the market is coming. Moreover, there are some technical clues that suggest that the move, when it materializes, may be to the upside.”
In fact, what we saw last week was a continuation of the same positive dynamic, as the New York Stock Exchange Advance-Decline line (NYAD) is on the verge of an upside breakout. Bullishly, NYAD found support at its 20-day moving average, moved steadily and closed the week of July 17 at the cusp of a new high. Thus, barring something very negative, the odds favor a new up leg in stocks.
The S&P 500 (SPX) defended the support area near 3200, delivering another positive for the bulls (see chart below).
Meanwhile, the Nasdaq 100 (NDX) held above key short-term support after some profit taking (see chart below). NDX made a new high the prior week.
Trade what You See
The mainstream viewpoint is that the global economy will crash under the weight of insurmountable debt and that the stock market will follow. My position is that as long as the stock market remains in an uptrend there won’t be such a crash because the stock market is now the leading variable in MEL.
Indeed, despite the current pandemic and the ensuing and related consequences, the Fed’s mega QE, despite its recent slower pace of injecting money into the bond market, seems to be keeping the crash scenario from fully unfolding. What this means, only from a trading standpoint is that the trend is up. Therefore, investors should be looking to make money on the long side as long as the trend and the indicators remain reliable.
Does that mean that we are reckless? Of course not; risk management remains highly important. As a result, keeping positions small, using sell stops, and monitoring trades on a daily basis remain the basis of our success.
So, what could derail what could be another up leg in the bull market? Aside from a truly extraordinary event, the fate of the markets remains in the Fed’s hands.
I own shares in DHI.
Joe Duarte is author of Trading Options for Dummies, and The Everything Guide to Investing in your 20s & 30s at Amazon. To receive Joe’s exclusive stock, option, and ETF recommendations, in your mailbox every week visit here. I’ll have more for subscribers in this week’s Portfolio Summary. For a 30-day Free trial subscription go here. For more direction on managing the GILD trade, go here. For more on these portfolio management techniques and stock picks that work consider a FREE trial to Joe Duarte in the Money Options.com by clicking here. I discuss this topic below and offer further detailed guidance as to where the best places to invest are likely to be in my recently recorded Second Half Outlook report titled: “Taming the Uncertainty” which you can find here.
