First the Liquidity Crisis. Then the Smell of Money amidst the Economic Twin Towers.

October 27, 2024

Should we brace for impact?

Last Friday’s action in the stock market had the feel of a rug pull, suggesting that maybe we’re headed for a bit of a liquidity crisis.  It couldn’t come at a more confusing time as inflation and the concurrent global central bank easing cycle collide.

Regular readers may recall an article I wrote on September 15, 2024 titled: “A Point of Emergence Approaches as the Brave New World Needs Money and the Fed’s About to Hand Some Over,” with the subtitle “It just feels as if something big is about to happen.”

It looks as if the something big has begun.

The Smell of Money and Why QE is Coming

If the autumn breezes bring an interesting and intoxicating aroma your way, it’s probably the smell of money.  That’s because central banks are cutting rates and a bit of stealth QE may be in the offing. Yet the stock market’s recent action suggests that the smell of the stuff isn’t enough.  The market needs real money – sooner rather than later.

Because there is too much debt in the world – corporate, governmental, and personal - without a stock rally, the economy will remain sluggish.   And without QE, the stock market will flounder.

Stated plainly, if there was less debt in the world, growth would be more robust as the money allocated to debt servicing would be available to do the things that need to be done.  But, because of high debt levels, the money is just not there to the degree that it should be.

So, where does it all come together for investors? Liquidity, especially the extra money required to rebuild battered regions of the Southeast U.S. and simultaneously expand the infrastructure required to accommodate the AI related demand for power and data centers. 

When central banks cut rates and implement QE, the amount of money in the system rises and greases the wheels.  That pool of newly minted money will eventually work its way to the stock market, via institutional investors, 401 (k) plans, IRAs, and corporate stock buyback programs.  In turn, rising stock prices will increase the liquidity in the economy.

It’s called the M.E.L.A. System and you can get the details here.  The short version is that without the stock market, the economy doesn’t have enough liquidity to grow.  The down side is that QE, without the counterbalance of increased means of production to meet the demand fueled by the QE money Bazooka fuels inflation.  Inflation creates a vicious cycle which requires more money to do the same amount of work that it took twenty years ago.

So, if you don’t smell the money yet, just give it a while.  If you trade stocks, it will soon find its way to your nostrils.   The unfortunate side of the situation is that before the Fed hits the QE button, there will likely be a liquidity crisis.  And based on the stock market’s fade last Friday, we may in the early stages of such a development.

Stay Patient. Trade one day at time.

Making Sense of the Twin Towers

The Fed’s Beige Book described a sluggish economy with reductions in manufacturing and agriculture.  Banking is improving slightly while the housing market is stable.  Data centers are still boosting construction. Employment was stable with few layoffs. Workers are staying put.  Food prices are volatile and rents are flat or slightly lower. Health care costs continue to rise.

Meanwhile Canada’s central bank lowered rates again while noting it expects to continue its rate cutting cycle. Europe is on the road to even lower rates. China is just getting started and the Fed’s likely to cut rates at least once before the end of the year.

Yet, recent CPI data suggests that the rate of inflation’s decline in the U.S. may have stalled. Next week, we get PCE data, GDP, PMI, private payrolls, JOLTS, and the grand finale, the October employment data.

The Infrastructure Paradigm

When in doubt, focus on what’s working and follow the money.  Thus, focusing on sectors where supplies are tight and demand is stable, or rising is the key to success.  The two sectors of the market where the supply and demand scenario are most conducive are housing and infrastructure, although it may be prudent to pull back our horns a bit and wait for developments before diving in too aggressively.

Long term, fundamentals bode well for infrastructure. The proliferation of data centers to house AI servers remains in its early stages.  Moreover, the Southeast U.S. has been battered by two major hurricanes this year and that rebuilding is estimated to cost $53 billion in North Carolina alone.

That money will be spent on roads, sewage, plumbing, as well as rebuilding, repairing, and upgrading the electric grid.  It could take several years to fully restore and upgrade these hard hit areas. Thus infrastructure companies are likely to enter long term earnings upgrade cycles.

An ETF which brings many of these companies under a single roof is the First Trust American Renaissance ETF (AIRR), which has seen some profit taking of late, but is well worth considering if it holds above its 20-day moving average. Caution is warranted in the short term as the OBV line is declining as sellers are overtaking buyers.

Caution is Warranted on Homebuilders as Bond Yields Choke Liquidity

I recently recommended buying homebuilder stocks on the recent price dip. 

And while longer term, I remain bullish on homebuilders, recent action suggests staying patient here makes the most sense.  Supply and demand favor homebuilders who have changed their business models to meet current demand instead of overbuilding and getting crushed during down cycles.

There is some nuance, of course.  First, is pricing.  Because of tight supplies prices remain above their historical norm for many.  Yet, because the shortage is structural, things are not likely o change anytime soon, barring a complete financial meltdown.

The iShares Home Construction ETF (ITB) is suddenly showing some weakness.  A move to the 200-day moving average may develop.  On the plus side, the 30 level on RSI is rapidly approaching, signaling an oversold status and a possible buy on the dip opportunity.

U.S. Ten Year Note Stubbornly Remains Above 4%. 

Bond traders know that economic growth is flat.  Yet, the U.S. Ten Year Note Yield (TNX) remains stubbornly above 4%, as inflation concerns counter sluggish growth.  This rise in yields is a contributor to falling liquidity in the stock market.  Another negative is that the 200-day moving average for TNX is now support, which suggests yields may move higher in the short term even as they are well overextended (RSI near 70).

Mortgage rates are testing a key resistance level. Will the recent mortgage activity continue as panic sets in?  Get the details on this topic here.  If you’re not getting my FREE weekly real estate and interest rate updates, you can sign up here.

REITs Stall After Rallying on Slide in Existing Home Sales

The iShares U.S. Real Estate ETF initially got a lift last week on weak existing home sales. That means more potential renters are available.  By Friday, the joy had reversed.  The 50-day moving average remains good support. 

For short term and intermediate term trades often featuring housing and REITs click here.   If you’re an ETF trader, consider, Joe Duarte’s Sector Selector.  It’s FREE with your monthly membership to Buy Me a Coffee.  Sign up here.  If you’ve been thinking about starting a day trading career, my new book “Day Trading 101” will get you started on the right foot.

AD Line Breaks 20 Day MA. VIX Rises.

The New York Stock Exchange Advance Decline line (NYAD) broke below its 20-day moving average, a bearish development.  A test of the 50-day MA is now possible.  The RSI is well above the 30 area, which means this weakness could intensify.

The Nasdaq 100 Index (NDX) made a new high before a bearish reversal took hold on 10/25/24.  A retest of 19,500 is likely.

The S&P 500 (SPX) delivered a scary looking intraday downside reversal on 10/25/24.   A break below the 20-day moving average could lead to further weakness in the short term.

VIX Reverses to the Up Side

The CBOE Volatility Index (VIX), is back above 20. Expect volatility to increase in the short term.

VIX rises when traders buy large volumes of put options.  Rising put option volume leads market makers to sell stock index futures to hedge their risk and leads markets lower.  A fall in VIX is bullish signaling lower put option volume, eventually leads to call buying which is bullish as it causes market makers to buy stock index futures raising the odds of higher stock prices.

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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 - now in its third edition, The Everything Investing in your 20s and 30s and six other trading books.

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