I hate to be bearish. And maybe it’s just a passing thing.
But it’s hard to argue with the price charts at the moment. And their message is that the stock market is at a vulnerable spot. Moreover, that means that everything (MELA) is now vulnerable.
The Three Boogie Men
Up until last week, the stock market had been focused on whether the Federal Reserve would start tapering its QE. But now there are three new boogie men in town:
- The specter of higher taxes
- Reports that COVID-19 is making a comeback, based on both rising case counts and an increase in reported viral-related deaths, and
- a disturbing breakdown in the market’s breadth (see below for details).
So even as the Chinese central bank’s massive reduction in reserve requirements work their way through the global money markets and the Fed seems to have stopped its behind the back reverse repos, the White House and Congress are starting to push for higher taxes. As a result, when the news hit the wires on 7/14/21, what looked to be a promising rally ground to a halt, a fact that was exacerbated via the monthly options expirations (see below for details).
Meanwhile, the latest Beige Book suggests that inflation may not be as “transitory” as the Fed continues to note. This confirms the recent record-setting reading in CPI and what consumers are facing at the gas pump and the grocery store. And, by week’s end, there was more evidence suggesting that consumer behavior may be changing due to high prices, as the University of Michigan’s consumer confidence survey fell more than expected based on the likelihood that people are less likely to spend money at these prices.
Of course, there is no way to know whether the higher taxes will actually materialize. Even more uncertain is what will happen with the COVID situation. And of course, at least in public, the Fed continues to promote its ongoing QE. But what we can certainly see is the breakdown in the market’s breadth, which means the algos are seeing a change in the order flow from net buying to net selling and thus are adjusting their strategies from net long to net short.
All of which brings me once again to the bond market’s continued rally.
Is a Stall in MELA Dead Ahead? The Homebuilders May be the Canary in the Coal Mine
If stocks are the lifeblood of MELA, the complex adaptive system composed of the markets (M), the economy (E), people’s lives (L) and the algos (A), then think of bonds yields as the primary influence, outside of the Fed on L. That’s because borrowing costs are based on bond yields, and the most important borrowing costs are the interest rates attached to big purchases, such as car loans and houses.
So, if yields, such as the U.S. Ten Year Note Yield ($TNX), are falling, then why are homebuilder stocks (XHB) stuck in the mud? Moreover, the $TNX chart suggests that the rally in bonds could be reaching a turning point just above the 200-day moving average. In other words, if bond yields start to rise, then we could see an even more bearish picture appearing for stocks.
So it emerges that the problem with the homebuilders may have to do with the fact that, even though yields are low, they may be falling because bond traders are betting that consumers (L) are about to pull back since the stock market (M) is faltering. This, of course, suggests that the economy (E) may be heading for a stall. And, of course, it all comes together when the algos (A) sense a change in the order flow of stocks – from bullish to bearish – and, of course, act accordingly by selling and selling short.
Specifically, consider that Accumulation Distribution (ADI) and On Balance Volume (OBV) are now negative for XHB, as the ETF has recently broken below its 20- and 50-day moving averages while having failed to climb back above them. That means selling pressure is mounting. And if the economy follows housing, and the housing stocks are a key stock market bellwether… you get the picture.
So, unless things change, I expect that the good old bull market days are about to change, at least for a while.
Yield Fever Raises MGM Growth Properties
The recent decline in U.S. T-bond yields has juiced the shares of real estate investment trusts (REITS). Among the most interesting of late has been Las Vegas landlord MGM Growth Properties (MGP).
Sporting a nearly 5.6% yield, roughly three times that of the U.S. Ten Year note’s recent 1.3%, MGP is clearly an attractive alternative. Nevertheless, given its dependence on traffic to Vegas, the stock does not come without risk. This could well become noticeable if the COVID-19 delta variant becomes a major deterrent to travel and thus stunts the steady recovery in the global economy.
Still, the stock is on the verge of what could be a significant breakout near the $37 price area. Moreover, based on data from 7/16/21, it is nowhere near overbought, as RSI is well of the 70 area. Accumulation Distribution (ADI) and On Balance Volume (OBV) are also on the healthy side of the ledger and Volume by Price (VBP) shows little overhead resistance is present.
In other words, if the Fed doesn’t get more aggressive on its QE tapering, inflation doesn’t blow above 6% or higher and the delta variant doesn’t cripple the economy, MGP could be a place to gather for a while.
I own shares in MGP at the moment. You can review more stock and options recommendations with a FREE trial to Joe Duarte in the Money Options.com here.
We Are Now in a Bearish Breadth Divergence
Risk has increased in the market, as breadth has collapsed and the indexes are faring better than the market’s breadth. That means that the relative strength in the indexes is because a few large stocks are holding up as the rest of the market falters. And, unless this changes, the odds of lower prices are now well above even.
Last week in this space, I noted that there were new highs on the S&P 500 (SPX) but not the New York Stock Exchange Advance Decline line (NYAD) or the Nasdaq 100 (NDX) index. Moreover, I added: “This lack of confirmation, especially from NYAD, may prove to be a problem if not corrected. Of course, if NYAD makes a new high in the next few days, then the uptrend will again be confirmed.”
Unfortunately, NYAD not only did not confirm in a few days, but has actually broken down by closing below its 50-day moving average while its RSI fell well below the 50 area. Of course, given the way the algos work things, this Duarte 50-50 Sell signal could well be reversed and we could be well on our way to new highs in a few days.
However, it is also possible that there is no meaningful reversal to the upside this time and that we may head into some type of correction, perhaps even a bear market.
That’s because, even though the S&P 500 (SPX) did make a new high last week, the new high did not hold up. Even more disappointing is that the index, along with NDX, tumbled for the week. Both indices remained above their 20- and 50-day averages, which on the surface is a positive. However, when seen in the context of a failing NYAD, we are now in the mist of a bearish divergence in the markets.
In The Money Options
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, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.
To receive Joe’s exclusive stock, option and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst going back to 1987. His books include the best selling Trading Options for Dummies, a TOP Options Book for 2018, 2019, and 2020 by Benzinga.com, Trading Review.Net 2020 and Market Timing for Dummies. His latest best-selling book, The Everything Investing Guide in your 20’s & 30’s, is a Washington Post Color of Money Book of the Month. To receive Joe’s exclusive stock, option and ETF recommendations in your mailbox every week, visit the Joe Duarte In The Money Options website.