The Fed still has the market’s back, which means stocks can make all time highs, reports Joe Duarte.
The whisper consensus on Wall Street is that the end of the bull market is near, that the economy will never recover, that the market makes no sense and the fact that the public is largely investing in stocks signals that something very bad is about to happen. But over the last four years, the stock market and the U.S. economy have beaten the odds time and time again which means that if the variables add up just right once more, this bull market may still have longer legs than anyone expects.
Adding Apples & Oranges
Only one thing is certain, no one knows when the bull market will end. Meanwhile stocks keep climbing as complexity, the sum of the perpetual and always in motion forces that make the Universe work continue to exert pressure on stock prices. In fact, the one thing the bulls have going for them is that as linear analysts continue to wonder why stock prices continue to rise, complexity is shaping a transformational and evolutionary transition that has resulted from the Covid-19 pandemic and its wide ranging repercussions.
Indeed, it is because of the intense interaction between all the agents in the markets, the economy and people’s lives (MEL) system and the environment that we are seeing the current rise in stock. In other words, where in a hypothetical linear world all things are symmetrical and linear, in the real world there is no linearity, there is only complexity.
So where in a linear system; 2 + 2 = 4 may be referring exclusively to apples, in the complex world the sum of the equation may not be symmetrical, meaning that we may actually be adding apples and oranges. So, in the realm of complexity, 2 + 2 still equals 4 but it may be in the form of 3 apples and 1 orange or another combination of fruits. The bottom line, though, is that you still have 4 fruits in your basket.
Complexity leads to Adaptation
Now, consider this. As people leave one region of the country, perhaps New York City, the big apple unfortunately losses taxable income and commerce. Yet, the places where people move gain both financial and political capital, which means that for illustrative purposes, the aggregate sum of the transactions for the nation – i.e. GDP, remains in place, and perhaps even improves; you still have fruit in your basket although it may not be just apples.
In other words, if a person moves from New York to Texas, and buys a home from D.R. Horton (DHI) in Texas, DHI records the sale just the same as if the sale was made in New York. So, for accounting purposes, all things being equal under the current circumstances, in a complex system there is little meaningful difference for DHI as to whether they sell a house in New York or in Texas. Most importantly, the same principle applies to any company’s sales, revenues, and bottom line. Thus, from a stockholder’s standpoint, the number of fruits in the basket is more important than the type of fruit.
Evolution in Motion Shirks Dog Days of August
Interestingly, the net effect of this complex evolutionary process into the unknown is that the stock market is now widely and intimately involved with the economy and people’s lives via its connection to 401 (k) plans and individual trading accounts. Moreover, this transition has created a tangible and self-evident daily experience where investors, not just hedge funds, are doing better than non-investors. Furthermore because of the current climate those who fall asleep during the “dog days of August” in 2020 could miss out on the next wave of profits.
Don’t Fight the Fed and the Market’s Momentum
I’ve said it multiple times, but it’s worth repeating. The Federal Reserve will continue to put money into the financial system for the foreseeable future, which means that the odds will continue to favor higher stock prices. Of course, the market will have its ups and downs, and uncertainty will remain high.
But that uncertainty and the bearishness that it creates has proved to be the fuel for the bull market all the way from the 2009 bottom. So, unless something extremely surprising happens, the uptrend in stocks gets the benefit of the doubt until proven otherwise. Moreover, as the election nears, the likelihood of more government stimulus, along with no negative moves from the Fed are more likely than not to tilt the odds toward the bulls, warts and all.
Don’t Underestimate the Economy
Consequently, it makes sense to review these key factors:
- The Federal Reserve’s massive and ongoing liquidity infusion into the system will continue
- The adaptive nature of MEL, the complex adaptive system comprised of the markets, the economy and people’s financial decisions is self-renewing, and
- The central role of the 401 (k) and active trading accounts as transformational agents, which have flipped the traditional pecking order in MEL from one in which the economy leads the markets to one in which the markets now lead the economy is not likely to be reversed soon
In addition, as stronger than expected ISM and payroll numbers show, and more important, a reversal in consumer credit into the positive suggests, there seems to be an unexpected bounce in the economy that can’t be ignored, even if at the moment the stock market is the primary variable in MEL. And although it’s too early to know if such a bounce can last, if it continues, it can’t be ruled out as a potential boost to corporate earnings. Moreover, the effect of a surprise improvement in corporate earnings in the midst of the greatest monetary accommodation in the history of humanity is highly unpredictable but could ignite significant economic growth.
By the same token, as we get closer to the election, expect that events that were once considered extraordinary, even by today’s already dramatic standards, may be surpassed. Moreover, historically speaking the third quarter of the fourth year of the presidential cycle is statistically the most bullish.
Accordingly, investors should prepare for the perhaps once in a lifetime experience of what the next three months may offer. One potential winner is industrial satellite systems company Trimble Navigation (TRMB), which I will examine in more detail in tomorrow’s report.
NYAD Delivers Quiet Set of New Highs
The New York Stock Exchange Advance Decline line (NYAD), the most accurate indicator of the stock market’s trend since the 2016 election made several and mostly unheralded new highs last week, including one on Aug. 7 (see chart below). And that’s not a bad thing since low fanfare in a bull market is usually an indication that the uptrend still has legs.
The S&P 500 (SPX) continues to flirt with new highs, finally confirming the bullish action in NYAD (see chart below). Accumulation Distribution (ADI) and On Balance Volume (OBV) are very strong in SPX.
For its own part, the Nasdaq 100 Index (NDX), prior to Friday’s pullback has been making new highs, which is bullish on its own as it has confirmed the new highs in NYAD (see chart).
Don’t Fall Asleep in the Dog Days of August
Last week in this space, I suggested that the traditional low volume trading of August could lead to a pullback in stocks. So far, we haven’t seen exceptionally low volume and we haven’t seen meaningfully lower prices.
What we’ve seen is new highs in the major indices and the NYAD, which suggest that stock prices could still move higher as the Federal Reserve’s liquidity infusions into the banking system continue to fuel higher stock prices.
There are, however, some clouds on the horizon as the election nears and the political battles heat up at the same time that the situation between the United States and China becomes even more strained that it might have been right after the 2016 election surprise. What this means for active traders is that we really can’t afford to take time off. Indeed, all outcomes are uncertain and only those who recognize this one unifying truth and act accordingly will be able to move to the next level; whatever that is.
I own shares in DHI and TRMB.
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. For a FREE trial to Joe Duarte in the Money Options.com, click here. I pointed out in my second half forecast where I discuss sectors and stocks with the best potential for the next few months.
