The Federal Reserve’s move toward raising interest rates has created a difficult set of market conditions in which trader indecision is causing a trendless, stop-and-go, nearly-impossible-to-trade market.
Psycho Warfare by the Fed
A key component in any battle plan is to use psychological warfare as much as possible in order to preserve resources, which can then be deployed in the conquest-and-consolidation phase that follows open combat. Fed officials are following this playbook to the letter.
This central bank appears to want to repeat the 2003-04 market where stock prices plummeted before the initial interest rate rise, but then held up. That’s likely why they’ve been talking in a loud voice about raising interest rates aggressively – well ahead of the expected March launch of what the majority of observers expect to be a protracted and lengthy period that includes multiple rate hikes.
We are humbled to respond to the consensus estimate that there will be seven rate increases in the next cycle.
Is there a point?
This talk now, hope later strategy attempts to make the economy slow down by creating conditions that allow stock prices to fall meaningfully, although not irreparably, before interest rates rises. The Fed should raise interest rates no more than necessary to achieve the desired goal.
This, of course, is due to the fact that central bankers know full well that the stock market is a huge influence on the economy, which is the basic tenet of my MELA system – M (Markets), E (Economy), L (Life Decisions) and A (Algos) all working in tandem.
The market is the economy
Most of us are familiar with the fact that MELA is driven by the actions in the markets. This includes those who have IRAs and 401(k) plans as well as traders accounts. This sub-section of the population that is responsible for a large share of economic activity and the stock market doing well feels more confident in their spending. It is their spending that fuels economic growth. So, while the Fed may not want to break MELA’s back, it wants to push inflation out of its system.
Problem is, the current inflation is mainly being fuelled by the limitations of the supply-and-demand situation that emerged after the COVID pandemic. This has had a significant impact on how people live and work. It also comes with the government policies that have helped to shape these behavior patterns and strengthen them. These things take time to change. The Fed may find itself in more trouble than it can resolve, especially with the world drowning under its debt.
The negative effects on the economy could be worse and faster than the Fed models can predict.
The Edge of Chaos is your welcome
“The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. The edge of chaos is an area of bound instability which fosters order-and-order dynamic interaction.” – Complexity Labs
In the meantime, expect a continuation in the directionless market. This includes the large air pockets that we have seen recently in stocks with poor earnings and any news items which disappoint.
You can watch this video for more information on developing a trading plan, and how to approach this particular market. my latest appearance on StockCharts TV’s Your Daily Five.
You can learn more by clicking here. here).
NYAD New Low Suggests There’s More Trouble ahead
New York Stock Exchange Advance Decline Line (NYAD), and major stock indexes have continued to struggle. They repeatedly fail to exceed key chart resistance points. This suggests that sellers wait patiently for new opportunities to reduce their exposure to stocks in these price ranges. It is also interesting to note that every drop in price is followed by an increase in CBOE Volatility Index, which measures the volume of put options. While VIX rises with selling frenzy, it still has not moved above 30. This suggests that this difficult-to-trade market could continue for some time as bears have yet to capitulate.
VIX is rising, which means that there are more put options (bets on whether the market will drop). The result of increased put volume is that market makers sell put options and then, at the same time, hedge their bets with stock and index futures. What we are seeing is that traders have been compelled to place hedges and then take them down. Stop-and-go price movement is a result of this.
The Nasdaq 100 index, (NDX), has never been above its 200 day moving average. The index is still testing the lows but has not been able to breach this critical support area, just like SPX.
The S&P Small Cap 600 index (SML) again remained well below its 200-day moving average. SML has been going nowhere, but the rest of market is continuing to decline. This indicates that there is relative strength. It remains to be determined if this will mean that smaller stocks will take the lead in the next leg of the market.
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Joe Duarte, a former money manger and active trader is an internationally recognized stock market analyst. He has been in the business of investing since 1987. Eight investment books have been written by Duarte, one of which is the most popular. Trading Options for DummiesRating: 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 ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
Joe DuarteHe is an ex-money manager and active trader, as well as an independent stock market analyst. His work dates back to 1987. The best-selling Trading Options for Dummies is one of his books. He also has a TOP Options Book for 2018/2019, 2020 by Benzinga.com and Trading Review.Net 2020. His latest best-selling book, The Everything Investing Guide in your 20’s & 30’s, is 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 the Joe Duarte In The Money Options website.