At The Edge Of Chaos: It's Still About Easy Money And The Coronavirus

02/18/2020 9:40 am EST

Focus: STOCKS

Joe Duarte

Editor, Joe Duarte In the Money Options

The Stock market is clearly on pins and needles as traders weigh the unknown repercussions of the Coronavirus against the Federal Reserve’s bipolar actions regarding liquidity in the repo market. Not unexpectedly, the market may be entering a period where buyers take a break and just walk away while the algos run wild increasing daily volatility.

Last week, I noted that the market’s breadth had begun to deteriorate. Interestingly that didn’t last, as I will describe below, given the new high on the New York Stock Exchange Advance Decline line midweek. But even after that usually bullish development, the general vibe for stock traders is one of uncertainty, and with Monday being President’s day in the U.S. raising the potential for more algorithmic-based  volatility on news from China, many traders might just sit out the action for a while.

Of course, the big elephant in the room is the Coronavirus and the unknown effects it will have in terms of lives lost and the global economy, as all indications suggest that China was not ready for this type of event. Yet a stealth elephant to consider is the fact that the Fed has recently announced that it will begin to reduce the amount of money that it offers to the repo market over the next few months, which has been the main driver of the market’s gains since the fall of 2019.

But is that going to make a difference? Maybe not, because even as they reduce repo market liquidity, the Fed will continue its Treasury bill purchases with the net effect being a continuation of high levels of liquidity in the money markets, albeit via a backdoor. Thus, the bottom line is that at this point, in terms of macro trading, flesh and blood traders are scratching their heads and sitting back as the algos read the headlines and execute programs until the next headline hits the wires and the market again reacts.

Bonds Still Bet on Global Recession

The bond market remains a crucial indicator for the Markets-Economy-Life (MEL) complex adaptive system, and as traders hedge their bets against the potential for a global recession due to the Coronavirus, the U.S. 10-year note (TNX) continues to hover near its 12-month lows (see chart).

tnx

This has interest rate sensitive stocks, such as the Real-estate investment Trust (REIT) based iShares US Real Estate ETF (IYR) moving higher. The problem with this is that if the market rolls over, REITs may not continue to move higher. Moreover, given the fact that many REITs are backed by apartment rental and shopping center income, their earnings may be vulnerable if the economy rolls over and demand for high rent apartments declines.

That said, there is an emerging trend in the U.S. stock market where stocks such as Gilead Sciences (GILD), whose interesting niche in the markets as related to the Coronavirus which I profiled last week, is being joined by other biotech companies whose products may be useful in situations pandemic scenarios. I will address this in depth tomorrow.

Market Breadth Remains Jumpy

Last week I noted that the New York Stock Exchange Advance Decline line (NYAD) was starting to diverge from the major indexes, usually a sign that a decline in stocks may be on the way. But by midweek, NYAD managed to make another new high, which essentially negates the slight divergence that seemed to be developing. Nevertheless, by the end of the week, the new high had faded and trading turned sloppy. So, in the current environment, it’s a tough call as to which way things are going to go.

nyad

Certainly, NYAD is above its 50-day moving average as well as above the 50 area and below the 70 area on the relative strength index (RSI). Both of these indications are usually positive. The problem is that the market is too dependent on news about the Fed and the Coronavirus, which means that things could turn either very positive or extremely negative in a heartbeat.

spx

Both the S&P 500 (see chart above) and the Nasdaq 100 (see chart below) indices made new highs for the week, which were confirmed by NYAD. Thus, in normal times this would be a very bullish development. However, in the current market, this set of new highs should be viewed with an asterisk unless things change.

ndx

The bottom line is that the short term trend is too dependent on the Fed and the Coronavirus, making for a dangerous trading environment for anyone with a time frame, which extends beyond the next few minutes to hours.

Reduce Exposure to Stocks

As I’ve noted over the last few weeks, the best strategy at the moment is to reduce exposure to stocks unless there is a good reason to own particular shares. In other words, stocks such as Gilead Sciences and Emergent BioSolutions Inc. (EBS) make sense, albeit in prudent lot sizes (more on EBS tomorrow).

Thus, taking profits, picking only stocks whose niche and trading pattern is compelling, having lots of cash around and building a shopping list make the most sense for traders who want to hang around. Finally, although it is tempting, shorting this market should be avoided until it becomes crystal clear that it is warranted. Otherwise it could be very painful given the potential for something positive to develop at any time, which would destroy the doom and gloom of the Coronavirus in an instant as the Fed’s liquidity is likely to stay in force for the foreseeable future.

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 hereI’ll have more for subscribers in this week’s Portfolio Summary. For a 30-day Free trial subscription go here.
By the way if you couldn’t make it to Orlando for my Money Show presentation, you can see it here.

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