Don't make big bets just yet.
The stock market is treading on thin ice. Fear is running rampant, but several key support levels held last week. That suggests that, as painful as trading was, we may be making a panic bottom in stocks. If that's the case, then Santa Claus is loading the sled and the traditional year-end rally could start at any moment.
On the other hand, if these key support levels fail to hold, the selling will pick up speed and the decline into what could be a major bear market will likely be swift.
Liquidity Holds the Key as Fed Accelerates Taper Pace
Wow! The Fed is going to reduce its bond purchases – both treasuries and mortgage-backed securities (MBS) – by $30 billion per month and is scheduled to stop its tapering in the spring. Even more interesting, the central banks are penciling in three rate hikes in 2022.
Now, remember that the stock market is fueled by liquidity and that tapering drains liquidity. In addition, given the current pay-as-you-go, cash flow, just-in-time world we live in, when liquidity dries up, markets crash.
But here is where it gets a bit scary. Purchasing manager data from IHS Markit suggests that the economy is already slowing in the face of rising inflation. In addition, small business surveys are pointing to a potential weakening in the economy. So, the Fed may be tapering into an already slowing economy.
It's the Market, not the Economy, that Leads the System
Be that as it may, based on the central tenet of my MELA model – where M is for markets, E is for the economy, L is for people's life and financial decisions while A is for the role of artificial intelligence in the whole thing – the stock market runs the economy, not as traditional economists seem to think.
Here is a quick review:
- It's hard to make a living from working, so depending on trading and retirement plans such as 401 (k)'s and IRAs for financial support and spending money is widespread.
- When trading and retirement plans are doing well, because stocks are rising, people feel wealthy.
- People that feel wealthy spend money and the economy prospers.
- Algos speed up information and transactions, so people make decisions faster and the economy grows faster.
But, as we saw in March 2020 when the COVID pandemic hit, the markets fell apart and the economy followed. And it happened in record time because the algos sped up the process.
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
For more on how to develop a trading plan and how to approach this dip, watch my latest appearance on StockCharts TV's Your Daily Five.
American Tower: A Five-Percenter in an Uncertain Zero-Percent World
I recently recommended shares cell phone tower and mobile infrastructure real estate leader American Tower (AMT) on the basis of its dividend yield and its suddenly attractive price chart. But below the surface, AMT is a rare REIT; that is, one with potential growth. In other words, AMT provides the land for mobile carriers to place their towers, generating income from large, deep-pocketed corporate clients.
And business looks to be in excellent shape, all around the world. In the most recent earnings call, AMT noted the following future expectations:
- Extended multi-year growth based on accelerated expenditures by all carriers in the U.S. as the 5G rollout continues.
- A more rapid growth rate in the near term in Europe, where 5G is set to hit a growth spurt.
- Expanding presence in emerging markets as mobile phone use increases rapidly and there is insufficient infrastructure to service the growing demand.
- Aggressive network capacity expansion by all carriers around the world, leading to the company building as many tower sites in the next two years as it has built in the last five years.
And while those metrics may seem impressive, AMT's management is expecting that, as cloud use emerges, their tower sites will increasingly become not just radio transmission signal sites, but also mobile computing stations able to improve cloud-based operations for carriers. And, as this develops, it will increase AMT's revenue and earnings potential.
The price chart looks set to break out, with Accumulation Distribution (ADI) and On Balance Volume (OBV) moving steadily higher and the $280 price area providing the key chart point above, from which we could see a move toward $300.
All in all, with a 5% dividend yield, it may be worth being patient here, even if this stock just marks time for a while. This is especially prescient, with the Fed threatening to derail the bull market.
I own shares of AMT as of this writing.
VIX Fails to Rally on Op-Ex Day
It was quite the day on Friday, 12/17/21, with the market resembling a yo-yo. But VIX failed to move decidedly higher, which means that put volume was not overwhelming by the time it was all said and done. And that's a good thing – maybe.
Thus, as I note below, with NYAD holding above its 200-day line and VIX failing to make new highs, we could be making a panic bottom.
Options influence stocks because market makers are forced to hedge their market-making activities in order to preserve their solvency. Here are the details of how this works:
- Call buyers force market makers to sell calls.
- Market makers hedge their call sales by buying stocks and stock index futures – this causes the market to rise.
- The cycle self-reinforces as long as call buyers persist and the stock market moves higher.
The reverse is true when put buyers are in charge, as they were until 12/2/21. In other words, when put volume rises, it's because market makers are having to hedge their bets against traders who are betting against the market. This causes the VIX to rise, which, in turn, signals that the odds of a down market are rising.
So, when there are lots of call option traders, expect rising stocks, while high numbers of bearish option traders (put buyers) usually lead to lower stock prices.
The chart of the S&P 500 Volatility Index (VIX) and the S&P 500 (top panel) shows that rising VIX usually leads to lower SPX, while falling VIX usually leads to rising SPX. That's due to rising VIX signaling high put volume. (See above for what high put volume means.) So, at this point, what we're seeing is a market that is trying to put in a bottom. If VIX breaks out to new highs and the SPX breaks down, expect things to get worse in the short term.
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!
#1 New Release on Options Trading
Anatomy of a Panic Bottom – The 200-Day Moving Average for NYAD
The New York Stock Exchange Advance Decline line (NYAD) traded just above and just below its 200-day moving average temporarily last week, closing just below the key support level on 12/16/21.
But here is the good news: the RSI for NYAD has not made a new low, even as NYAD retests its 200-day line. That means that the sellers are getting exhausted. It's usually what happens in a panic bottom – the subsequent bottom after a major selloff, where the market retests the recent lows.
The S&P 500 (SPX) remained inside the 4500-4700 support band and, crucially, above its 50-day moving average, while RSI closed just below the 50 area. On Balance Volume (OBV) and Accumulation Distribution (ADI) did move lower, suggesting that selling picked up last week.
The Nasdaq 100 index (NDX) did break below its 50-day line, as selling picked up steam here as well.
Meanwhile, the S&P Small Cap 600 index (SML) failed to break below key support and ended the trading day on the up side. Both ADI and OBV improved, which means that the shorts are getting squeezed.
Good news! I've made my NYAD-Complexity - Chaos chart (featured on my YD5 videos) and a few other favorites public. You can find them here.
Joe Duarte
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.
The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as 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 https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
