As 2020 comes to a close, many of the worries and circumstances that have driven the market higher all year remain in place, and in many cases their intensity has risen, states Joe Duarte of In the Money Options.
The upshot is that fueled mostly by what I’m seeing in the market’s breadth and the action in the bond and currency markets over the last few days I have begun to evaluate the ability of this market to continue on the current momentum run regardless of central bank intervention unless something else gives.
However, as the month of December rolls on, investors should keep two things in mind. One is that stocks are in a bullish seasonal period with the Federal Reserve providing the fuel for higher stock prices. The other, is that all momentum runs end badly and this one won’t be any different when its time comes.
Yet, as time passes it is possible that this uneasy truce between seasonality and central bank easing is reaching a decision point due to political developments. And how the bond and currency markets respond to whichever way any of these major situations break will be what dictates the action in the stock market, perhaps over the next several months or longer.
So, here is what we know:
- Options expire on December 18, a fact which could increase volatility.
- Pfizer’s (PFE) COVID vaccine rollout in the US begins. Moderna’s (MRNA) vaccine goes up for FDA approval.
- The Fed will keep printing money and buying bonds and results of banking stress tests will go public this week. Meanwhile FOMC will meet on 12/16.
- Other central banks will continue to join the Fed’s QE efforts.
- In a zero-interest rate environment, stocks make sense since there is no other way to make money, but this is not without risk.
- There are three major political issues, which are weighing on the markets and which may be decided in the next two weeks: the US election, a second stimulus package in the US, and Brexit.
- The global economy remains in an uncertain place due to the COVID-19 pandemic and the sporadic regional shutdowns of cities.
- The bond market, because of the economic uncertainty, should be rallying in prices and yields should be falling but this is not happening very convincingly at the moment.
- There may be some holiday- and risk-averse-related liquidity issues as the year comes to a close putting the market at risk.
Now, here is where the problem lies. The Fed is buying $130 billion worth of bonds (treasuries, T-bills, mortgage-backed securities and other debt instruments) every month and has been doing so since summer 2019. Yet, the US Ten-Year-Note Yield (TNX) is actually rising. Moreover, TNX is nearing the 1% yield area, where it has not been in quite a while. And although bond yields did not cross above 1% as of the end of the week, the trend for yields seems to be up now as long as TNX holds above its 50-day moving average. What this tells us, until it is reversed, is that the Fed isn’t buying enough bonds to keep rates from rising, which means that if the Fed doesn’t crank up their purchases interest rates are going to rise. And of course, stocks won’t like that one bit.
Furthermore, when you look at the condition of the US dollar (USD), you see that the greenback has been in a bear market for several months. This, of course coincides with the Fed keeping interest rates low by buying bonds, since low interest rates usually lead to a lower underlying currency. But a closer look at USD shows that it is now very oversold and that usually means that money will look to buy.
But here’s where it gets interesting. A rising currency usually means that expectations for higher interest rates are creeping into the market. Even more compelling is the fact that the US dollar is still considered a safe haven. Putting the rising bond yields and the bottoming dollar together, especially when stocks are starting to look a little top heavy, you can see why this may not be a bad time to cash in some chips or do a little hedging.
To learn more about Joe Duarte, please visit JoeDuarteintheMoneyOptions.com.