The stock market stumbled into 2024. But under the hood, until proven otherwise, the action resembles a sector rotation more than a full-blown correction. Because of the magnitude of the Q4 rally, this consolidation/rotation could last a while. As a result, it makes sense to focus on where the money is flowing, as we wait for the setup for the next rally.
Here's a summary of key factors as of 1/5/24:
- The Fed is not very likely to raise interest rates; but
- Sentiment is still too bullish, as the CNN Fear/Greed Index closed at 74, well within the GREED zone;
- The CBOE Put/Call Ratio closed at 1.15, an acceleration of the bearish tone (bears are watching); and
- The CBOE Volatility Index (VIX) remained below 15 – a sign that put option volume remains stable and that the rise in the P/C ratio is being influenced by a decrease in call option buying, not a rise in the volume of put options.
Together, these indicators suggest that the market is likely to remain in a bumpy consolidation pattern. What that means is that a combination strategy is required, involving taking profits where warranted, buying dips as they materialize, and deploying money into new areas that are exhibiting relative strength, while keeping a wary eye on the external factors which affect daily trading and how the markets respond.
Indeed, it's always best to be prepared, which is why these basic tenets are worth repeating:
- Stick with what's working; if a position is holding up – keep it;
- Take profits in overextended sectors;
- Consider some short term hedges;
- Look for value in out of favor areas of the market that are showing signs of life; and
- Protect your gains with sell stops and keep raising them as prices of your holdings rise.
Remember also that market declines eventually lead to market rallies. And as I described in my latest Your Daily Five video, it's best to focus on value during a market decline. Specifically, pay attention to those areas of the market which hold up better than others. For a detailed plan on which areas of the market make sense currently, consider a FREE Trial to Joe Duarte in the Money Options.com.
Bond Yields Bend, But Don't Break
Stock investors who ignore the bond market are missing a crucial intermarket relationship. As the price chart below shows, since stocks bottomed in October 2023, the yield decline in the U.S. Ten Year Note yield (TNX) and the rally in the S&P 500 Index (SPX) have been highly correlated, which is why what happens to bond yields over the next few days to weeks will be a big influence on stocks.
Specifically, investors should focus on the 4-4.1% yield range for TNX, which, as I've repeatedly highlighted, will set the tone for what happens next. That's because the action above and below this point is used to trigger algo trading programs. Moreover, a break above 4.1%, or a fall below 3.8% will likely trip mechanical trading programs, which will in turn trigger related programs in stocks. Otherwise, expect choppy trading if TNX remains in this range.
What's Working in Early 2024? QQQ Short Squeeze is Possible
Algos who trade based on what happens in TNX often use the Invesco QQQ Trust (QQQ) as the vehicle for the stock portion of their strategies. Note that a rise in TNX has been followed by a fall in QQQ lately. Currently, QQQ is trading below its 20-day moving average and looks headed for a test of the 50-day line. The ADI and OBV indicators are diverging, with short sellers betting on lower prices (falling ADI) and buyers creeping back in (bottoming OBV). With the RSI at 50, there is the potential for a snap back rally in QQQ as the shorts get squeezed. Stay tuned.
The big money magnet in the early days of 2024 is the large pharmaceuticals sector. The VanEck Vectors Pharmaceutical ETF (PPH) has quietly ramped above its August 2023 heights on heavy short-covering, as illustrated by the sharp rise in ADI, while buyers are slowly coming back as OBV perks up. PPH is overbought, but its action is indicative of where the market's action may be headed in 2024.
On the other hand, as I noted in my last few posts for 2023, the shipping stocks are likely to remain near the top of the leaderboard as long as the situations in the Red Sea and the Panama Canal are not resolved. The SonicShares Global Shipping ETF (BOAT) is overextended currently, but is not showing any signs that selling pressure is increasing.
If you saw this post , you would have been prepared for the rally in the shipping stocks. For detailed Buy and Sell recommendations on shipping and pharmaceutical stocks, click here.
Market Breadth Recovers
The NYSE Advance Decline line (NYAD) broke out in late December and has pulled back to its prior resistance point which now becomes key support – roughly at the 20-day moving average. If this area holds, it will be a very bullish development for the market.
The Nasdaq 100 Index (NDX) rolled over at the start of the year, but has held above 16250, which is the top end of a three-bar VBP cluster (horizontal bars at left of chart). The VPB cluster extends as far down as the 50-day moving average, and chighlights an important support range which may be tested before the market decides on its next move. NDX is no longer overbought, with ADI falling and OBV rising, which means a short squeeze may materialize.
The S&P 500 (SPX) is in a similar technical posture to NDX, and is currently testing support at its 20-day moving average.
VIX Remains Below 20
The CBOE Volatility Index (VIX) remains stubbornly below 20, which remains a bullish posture for stocks. If VIX remains subdued, more upside is possible.
A rising VIX means traders are buying large volumes of put options. Rising put option volume from leads market makers to sell stock index futures, hedging their risk. A fall in VIX is bullish, as it means less put option buying, and it eventually leads to call buying. This causes market makers to hedge by buying stock index futures, raising the odds of higher stock prices.
To get the latest information on options trading, check out Options Trading for Dummies, now in its 4th Edition—Get Your Copy Now! Now also available in Audible audiobook format!
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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.
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