Does it make sense for the Fed to taper as a "fourth wave of COVID" begins to develop?
Welcome to the Edge of Chaos:
"The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder." – Complexity Labs
Talk about that butterfly flapping its wings, eh? Sure enough, recent events suggest that the combination of a pandemic surge simultaneous with the start of the Fed's QE tapering may be too much for the stock market to handle, despite its heading into what is usually a very positive season.
Not Another Perfect Storm, Please
Let the games begin. The Federal Reserve will be reducing its bond purchases by $10 billion per month starting in December, formalizing the beginning of the tapering of its COVID-19 pandemic record-setting QE. And while the stock market initially took the news in stride, it seems as if traders are suddenly running for the exits. Here we go again, as the CTA algos hit the sell button on the headlines and the equally-algo market makers adjust to the flow of orders with the result being
The stock market's breadth, as I describe below, swooned last week, as news reports of rising COVID numbers and the expansion of lockdowns in Europe (Germany, Austria, Gibraltar) hit the wires. Moreover, even if it's suddenly not a hot topic, there is that unresolved matter of the Fed starting its taper gaining weight if a revived COVID season delivers another blow to the global economy.
Sure, we can always blame the options expiration cycle (11/19/21) for the market's recent bumpiness. And there is a certain amount of truth to that, given that recent trading metrics in options showed that options trading was 1.4 times the size of stock trading. So, yeah, the tail is definitely wagging the dog.
Still, what really matters is whether $10 billion less of free speculating money for the big banks per month will be enough to make the market roll over meaningfully, especially in the presence of a potential new set of COVID-related lockdowns amid the current inflation and supply chain situation.
So, for now, we trade the market on the long side for now, but continue to:
- Take profits sooner
- Use tighter sell stops
- Not lose sight of the fact that the odds favor that we are closer to the end of the current rally than many may realize
In addition, if the market reacts to COVID as it has in the past, we can expect money to flow to sectors which could benefit from an extended lowdown. I feature a stock which could fit that bill just below. For more info on how to adjust your trading approach to this market, check out my recent interview with StockCharts.com's Dave Keller here or my latest Your Daily Five video here.
There are still some stocks and option strategies which may yield sizeable gains when properly managed. You can see my latest recommendations with a FREE trial to my service here. You can also check out one of my recent Your Daily Five videos, which expands on these strategies, here.
YETI: Cool Products, High Growth Rates, Clever Management and High Holiday Expectations
I recently recommended shares of outdoor and recreational products powerhouse Yeti Holdings (YETI), as the stock seems poised for a major upside breakout.
Yeti is best known for its metal cups, but has a broad range of products aimed at the outdoors, recreational and working markets, which makes its wares ideally suited for filling holiday stockings -- especially if more COVID lockdowns cause a resurgence of outdoor activities.
But, away from the obvious, YETI is an interesting management story. That's because, unlike other companies, it has begun to limit its wholesale partner numbers to around 3000. And while at first glance that may sound like a negative, it's actually an excellent move as the company is planning to increase its business with the strongest of its partners. In other words, they are playing to their strengths. Moreover, the company is slowly developing its own retail presence, but is not doing it at an unsustainable pace, which will keep expansion costs under control.
As a result, the company's recent results and guidance are quite bullish:
- 23% revenue growth year-over-year
- 31% growth in direct-to-consumer sales
- 69% growth in international sales
- 57% growth combined over the first three quarters on 2021
- 20% margin growth
- Increasing focus on e-commerce combined with key placement of vendors
In addition, the company is expanding its margin growth rate for the year from 20.5% to 20.8%. On the down side, they are, like everyone else, concerned about supply chain issues and higher costs of doing business.
The stock is in a bullish accumulation pattern, with a breakout point near the $108 level and solid support near $100. Accumulation Distribution (ADI) and On Balance Volume (OBV) are trending higher and the stock's recent sideways action has worked off a big portion of its overbought level, with RSI back to the 50 area.
Finally, the company should get a nice boost from holiday sales, which could well lead to a nice beat on its Q4 earnings. So, once Wall Street starts to work that into the equation, I would expect the stock to move higher.
Bullish Tone in Options Market Faded at 4700 on SPX
Options traders turned bearish at 4700 on SPX and near the 470 area on SPY, as evidenced by rising put option activity and the subsequent hedging. As a result, stocks rolled over on Friday's option expiration. The real question is what the market will do during the holiday-shortened week, with thin volumes and the potential for bad news on COVID.
How does the options market affect stocks? Here are the simple steps again:
- Call buyers force market makers to sell calls
- Market makers hedge their call sales by buying stocks and stock index futures
- The cycle self-reinforces as long as call buyers persist and the stock market moves higher
The opposite is true when put buyers are in charge. The bottom line is that the stock market's trend is highly influenced by the sentiment and the action in the options market.
In other words, bullish option traders (call buyers) usually mean rising stocks and bearish option traders (put buyers) usually lead to lower stock prices.
To get the latest up-to-date information on options trading, check out Options Trading for Dummies, now in its 4th Edition – Get Your Copy Now!
Market Breadth Bends as Early Divergence Develops
The New York Stock Exchange Advance Decline line (NYAD) rolled over last week, delivering a note of caution to what was starting to be a good start to the usual holiday rally. Nevertheless, NYAD remained above the support of its 20- and 50-day moving averages, which is a positive.
At the same time, however, the RSI fell below 50. That said, only when NYAD breaks below its 50-day moving average and falls below 50 on RSI simultaneously do we consider it a Duarte 50-50 sell signal. Still, it's quite clear that the market's breadth is weakening, so caution is warranted.
Even more cautionary is the fact that the major indexes rallied in the face of weakness in NYAD, which is of major concern if it is not corrected.
The S&P 500 (SPX) made a new high last week, which was not confirmed by NYAD. This is a developing divergence.
The Nasdaq 100 index (NDX) also confirmed the recent high on NYAD. Even better, the NDX breadth line made a new high, with Accumulation Distribution (ADI) and On Balance Volume (OBV) confirming.
Meanwhile, small stocks (SML) rolled over along with NYAD, a clear sign that most of the money in stocks is suddenly moving into large stocks, which may not be healthy over the long haul.
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.