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Stocks are Safe, but Fed Needs to Keep Feeding it QE

07/07/2020 9:16 am EST

Focus: STOCKS

Joe Duarte

Editor, Joe Duarte In the Money Options

While fears of a downturn didn’t materialize last week, stock investors need to know the Fed has their back, writes Joe Duarte.

The bulls lived to fight another day last week as the potential sell signal from Duarte’s 50-50 Rule did not come to pass. So for now, instead of a “cruel, cruel summer” investors seem to have just gotten lucky once again, especially when you consider the fact that the Federal Reserve will likely rev up the QE machine in the not too distant future.

Certainly, liquidity is the dominant theme in the market. Moreover, there are emerging signs that the Fed’s lack of largesse in terms of money creation is starting to create yet another potential freeze up in bond land, which if not remedied, will turn into a problem for the stock market.

That was a Close Call

We almost got a big time sell signal last week as the 50-50 rule, which is triggered when the New York Stock Advance Decline line (NYAD) breaks below its 50-day moving average as its corresponding relative strength index (RSI) indicator breaks below its 50 line. But we are not out of the woods. That’s because the Federal Reserve is still only pumping $4.5 billion into the Treasury market daily, which — as the stock market’s recent hiccups suggests — is simply not enough money to keep the stock rally going.

Last week, in this space, I noted: “The way this market has acted over the last few months, it could well set a new high in a few days. However, if the NYAD breaks below its 50-day moving average, a trip to its 200-day moving average is well within the normal technical expectation. That could translate into fairly steep losses for individual stocks and the major indexes.”

Thankfully, the bulls got a reprieve. But as I noted above, the Fed is likely to increase its money pumping into the bond market, but the central bank is still not all in. Moreover, we have not received the all clear signal that the bull market is back in business. Thus, we are in familiar territory which means that, above all, attention to individual positions and adherence to sound trading principles is the key to success as we wait for the Fed’s next move.

Here is a review of the keys to success:

  • Stay with the market’s primary trend
  • Trade small positions to reduce portfolio volatility
  • Don’t fight the Fed’s interest rate trend
  • Take profits on positions that are consolidating, prices or no longer acting well
  • Constantly look for stocks displaying positive chart patterns when management is doing the right things for the business
  • Maintain and adjust well-placed sell stops as your stocks rise and
  • Always be prepared for when the music stops

MEL Anecdotal Evidence Holds Up

Aside from the market’s lack of a bearish break, which is great news, the macro data tells us that before the recent surge in new Covid-19 spike; people were going back to work, consumer confidence was rebounding and as reported by PMI data, the U.S. economy had seemed to bottom out. The problem is that we really don’t have any data which tells us what’s happening after the latest surge in Covid-19 cases.

Indeed, the constant worrying remains a bullish factor as the one consistent dynamic of this entire bull market from the bottom in 2009 has been the presence of a persistent wall of worry. Moreover, when that wall of worry began to dissipate in the late spring, after the March bottom, the market started showing signs of topping out.

In fact, just before the Covid-19 resurgence I asked subscribers to send me anecdotal information about their geographical areas. I was looking for information to help me make sense of the state of the complex adaptive system of the Markets, the Economy and people’s Lives (MEL).

What I received painted a fairly positive picture, similar to what I was seeing in Dallas at the time; clear signs of increased activity in the form of full freeways, improved traffic at restaurants and grocery stores, and mostly active retail activity, especially at places like Home Depot (HD) and grocery stores.

Interestingly, one subscriber from California, also noted heavy traffic at Home Depot, but also empty shelves, which I have not seen to a great degree at HD. I’ve also heard general misgivings about the potential for Christmas merchandise being delayed this year. Someone from Florida astutely noted decreasing traffic in the Brickel financial district in Miami, just days before the Covid-19 surge hit the mainstream media, which suggests that the number of Florida cases was already rising.

A sub from Chicago noted muted activity in small restaurants in his area and wondered if these small businesses were going to make it. Meanwhile someone from Pennsylvania reported concerns about the future of the education system in his area due to kids not sure about returning to school in the fall.

What this anecdotal evidence, combined with the improving employment and economic data suggests, is that before the surge, we were starting to see a recovery, albeit somewhat uneven in multiple areas of the country and not without risk to certain sectors. Just the same, since there seems to be a reasonably good correlation with what we’re seeing in terms of on the ground data, it’s important to keep tabs on this type of information.

Join the MEL Brigade

So now, I’m looking for clues as to what’s happening now in MEL as the Covid-19 cases increase across the country. Specifically, it’s good to know what’s happening in real time.

Presently, what I’m seeing in Dallas is a slight decrease in freeway traffic combined with a pronounced decrease in major avenue traffic while retail seems to be holding up.

Trend Remains Up as NYAD Rebounds

The NYAD remained above its 50-day moving average last week while the corresponding RSI indicator bounced back above its 50 day line. That means that until proven otherwise, the trend for the stock market remains up and the 50-50 Rule sell signal did not materialize (see chart below).

nyad

 The S&P 500 (SPX) also recovered and closed the week above its 200-day moving average reversing what seemed to be a darkening picture for the stock market (see chart).

spx

 Moreover, the Nasdaq 100 (NDX) made a new high with a significant rise in Accumulation Distribution (ADI) and On Balance Volume (OBV) suggesting that money is moving back into the stock market (see chart).

ndx

What we need to see now, however, is a new high on NYAD to confirm the move in NDX. If there is no confirmation in the next few days, we would have a potential negative divergence, which could be a prelude to yet another opportunity for the 50-50 rule to give us a sell signal.

Bulls Should Remain Cautious

The bull market escaped a potentially sizeable decline last week. And while that was a positive development, all the market accomplished was the avoidance of a major breakdown. What we need to see now is a resumption of the upward momentum as would be signaled by a new high on the NYSE Advance Decline line.

I’m not expecting any slowing or changes in the political warfare that is ongoing or a sudden end to the Coronavirus pandemic. So what it all boils down to for the stock market, as it has for the past several weeks, is whether the Fed will convince the market that its current $4.5 billion daily injection into the Treasury bond market along with its other interventions will be enough to keep the stock market liquid or whether the market will increase the pressure on the Fed to juice up the QE machine once again.

We should know soon.

For more details on the summer trading season catch my most recent Your Daily Five installment here. To subscribe for a FREE trial to Joe Duarte in the Money Options.com, click here. I have compiled a small list of companies whose stocks are showing relative strength and may be worth owning. The list can be accessed via a FREE trial to Joe Duarte in the Money Options.com To subscribe to my service, click here

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