Analysis, Perspective, Trading Strategy

At the Edge of Chaos: It’s Still about Easy Money and the Coronavirus

Editor Joe Duarte in the Money Options

The Stock market is clearly on pins and needles as traders weigh the unknown repercussions of the coronavirus against the Federal Reserve’s bipolar actions regarding liquidity in the repo market. Not unexpectedly, the market may be entering a period where buyers take a break and just walk away while the algos run wild increasing daily volatility.

Last week, in this space, I noted that the market’s breadth had begun to deteriorate. Interestingly that didn’t last, as I will describe below, given the new high on the New York Stock Exchange Advance Decline line midweek. But even after that usually bullish development the general vibe for stock traders is one of uncertainty, and with Monday being President’s day in the U.S. raising the potential for more algo volatility on news from China, many traders might just sit out the action for a while.

Of course, the big elephant in the room is the coronavirus and the unknown effects it will have in terms of lives lost and the global economy, as all indications suggest that China was not ready for this type of event. Yet a stealth elephant to consider is the fact that the Fed has recently announced that it will begin to reduce the amount of money that it offers to the repo market over the next few months, which has been the main driver of the market’s gains since the fall of 2019.

But is that going to make a difference? Maybe not, because even as they reduce repo market liquidity, the Fed will still continue its Treasury bill purchases with the net effect being a continuation of high levels of liquidity in the money markets, albeit via a backdoor. Thus, the bottom line is that at this point, in terms of macro trading, flesh and blood traders are scratching their heads and sitting back as the algos read the headlines and execute programs until the next headline hits the wires and the market again reacts.

By the way if you couldn’t make it to Orlando for my Money Show presentation, you can see it here.

Bonds Still Bet on Global Recession

The bond market remains a crucial indicator for the Markets-Economy-Life (MEL) complex adaptive system, and as traders hedge their bets against the potential for a global recession due to the coronavirus, the U.S. Ten Year Note (TNX) continues to hover near its twelve month lows.

This has interest rate sensitive stocks, such as REITS (IYR) moving higher. The problem with this is that if the market rolls over, REITS may not continue to move higher. Moreover, given the fact that many REITs are backed by apartment rental and shopping center income, their earnings may be vulnerable if the economy rolls over and demand for high rent apartments declines.

That said, there is an emerging trend in the U.S. stock market where stocks such as Gilead Sciences (GILD), whose interesting niche in the markets as related to the coronavirus which I profiled last week, is being joined by other biotech companies whose products may be useful in situations where pandemic scenarios, especially those related to germ related warfare, as I discuss below.

Emergent Biosolutions: The other Virus Stock to Consider

Shares of Emergent Biosolutions (EBS) have recently been moving steadily higher. That’s because this mid size biotech is well positioned in vaccines for germ warfare, bioterrorism, and a key antidote for opioid overdoses.

Unfortunately, the stock can be frustrating to trade as given its generally low profile, it often moves with thin volume making for choppy action. Still, if you’re looking for a company which is well positioned in case of a biological catastrophe, EBS is near the top of the list, and here is why. It has the exclusive contract for the U.S. government for filling the stockpile for anthrax vaccine, and has just signed a multiyear, multibillion contract with the defense department for the next generation of anthrax vaccine which is already in production and in the early delivery phase, a fact that should be noticeable on the bottom line over the next few quarters.

It’s also in late stages of a vaccine for a mosquito transmitted virus (chikungunya), which can be similar in symptoms to the Zika virus and dengue fever, potential plagues over the summer months. Moreover, EBS is likely to receive exclusive European approval for an oral cholera vaccine in the next few months. The likely scenario is that a majority of the millions of European travelers, who often frequent endemic cholera regions of the world, will be receiving the vaccine which has been available in the U.S. since 2016.

EBS will report earnings on 2/20/2020 and is likely to move in response. It beat expectations in its November 2019 report after missing the previous three times. However, the company did give positive guidance for 2020 after the November report and the stock has been moving steadily higher since early February. This trading pattern suggests a positive buzz for a beat. Nevertheless the company can disappoint so small positions may be warranted for those who decide to take a bite.

Market Breadth Remains Jumpy and Difficult to Decipher

Last week I noted that the New York Stock Exchange Advance Decline line (NYAD) was starting to diverge from the major indexes, usually a sign that a decline in stocks may be on the way. But by midweek, NYAD managed to make another new high, which essentially negates the slight divergence that seemed to be developing. Nevertheless, by the end of the week, the new high had faded and trading turned sloppy. So, in the current environment, it’s a tough call as to which way things are going to go.

Certainly, NYAD is above its 50-day moving average as well as above the 50 area and below the 70 area on RSI. Both of these indications are usually positive. The problem is that the market is too dependent on news about the Fed and the coronavirus, which means that things could turn either very positive or extremely negative in a heartbeat.

Both the S & P 500 (SPX) and the Nasdaq 100 (NDX) indices made new highs for the week, which were confirmed by NYAD. Thus, in normal times this would be a very bullish development. However, in the current market, this set of new highs should be viewed with an asterisk unless things change.

The bottom line is that the short term trend is too dependent on the Fed and the coronavirus, making for a dangerous trading environment for anyone with a time frame which extends beyond the next few minutes to hours.

Reduce Exposure to Stocks

As I’ve noted over the last few weeks, the best strategy at the moment is to reduce exposure to stocks unless there is a good reason to own particular shares. In other words, stocks such as Gilead Sciences and Emergent Biosolutions make sense at the moment, albeit in prudent lot sizes.

Thus, as I’ve noted repeatedly, taking profits, picking only stocks whose niche and trading pattern is compelling, having lots of cash around and building a shopping list make the most sense for traders who want to hang around and do this for a long time. Finally, although it is tempting, shorting this market should be avoided until it becomes crystal clear that it is warranted. Otherwise it could be very painful given the potential for something positive to develop at any time which would destroy the doom and gloom of the coronavirus in an instant as the Fed’s liquidity is likely to stay en force for the foreseeable future.

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 sellingTrading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com - now in its third edition, The Everything Investing in your 20s and 30s and six other trading books.

Meanwhile, the U.S. Ten Year note yield (TNX) is trading in a The Everything Investing in your 20s & 30s at Amazon and The Everything Investing in your 20s & 30s at Barnes and Noble.

A Washington Post Color of Money Book of the Month is now available.

To receive Joe’s exclusive stock, option, and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.

JoeDuarteInTheMoneyOptions.com is independently operated and solely funded by subscriber fees. This web site and the content provided is meant for educational purposes only and is not a solicitation to buy or sell any securities or investments. All sources of information are believed to be accurate, or as otherwise stated. Dr. Duarte and the publishers, partners, and staff of joeduarteinthemoneyoptions.com have no financial interest in any of the sources used. For independent investment advice consult your financial advisor. The analysis and conclusions reached on JoeDuarteInTheMoneyOptions.com are the sole property of Dr. Joe Duarte.