The U.S. stock market is at an inflection point, as all eyes are on a potential trade deal with China. There’s a March 1 deadline for reaching an agreement.
How should prudent investors navigate this situation? It may not be as straightforward as you think. Let’s examine the issue with the help of a chart.
Please click here for a chart of S&P 500 ETF SPY, -0.04% Similar conclusions can be drawn from charts of the Dow Jones Industrial Average DJIA, -0.29% Nasdaq 100 ETF QQQ, -0.15% and small-cap ETF IWM, +0.47% Please note the following:
• The chart shows that the market is up against the resistance zone.
• Please click here to see the last buy signal given by the ZYX Asset Allocation Model. The chart shows both the long term Arora buy signal and also the buy signal for a short-term trade. For the sake of transparency, this chart is exactly the same as previously published without any changes.
• The Arora Report had been projecting that earnings growth was about to slow. However, the market was slow to recognize this fact.
• The swoon in December was, in part, due to wider recognition that earnings growth was about to slow.
• As shown on the chart, the rally this year is due to the Federal Reserve doing an about-face and becoming dovish.
• RSI (relative strength index) shows that the market is overbought. Overbought markets are vulnerable to pullbacks.
• The pattern that RSI has traced often leads to strength after a pullback.
• Volume on the rally is lower than the volume during the swoon. On the surface this seems negative. However, the volume is higher than it was during the rally of July to September of last year. This is positive.
• It makes sense to look at popular tech stocks such as Apple AAPL, -0.33% Facebook FB, -1.04% Amazon AMZN, +0.09% and AMD AMD, -0.63% Those stocks have rallied strongly. Even though momo crowd money flows remain strong, it is of note that smart money flows are weak relative to the strength of the rally. Please see “If you own Apple, Amazon, Facebook or AMD, look out below.”
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Chances for a good trade deal
Let’s start with Arora’s Second Law of Investing: No one knows with certainty what is going to happen next. The only reasonable approach investors can take is to look at probabilities of various scenarios.
In this case, President Trump deserves credit for taking on an important issue. However, Trump also wants a deal, as he faces re-election. Under the circumstances, here are the scenarios.
• A good deal: The probability is low because the Chinese situation is such that they cannot afford to give the U.S. a good deal.
• No deal: This is likely in the best interest of the United States for the long term, as eventually China may give in. However, this will hurt Trump’s re-election efforts. Therefore, this is also a low-probability scenario.
• Bad deal: By exclusion, this is the most probable scenario.
What to do now
Our projection at The Arora Report is that the momo (momentum) crowd will buy on the announcement of a trade deal, but the smart money will sell into the strength. This will generate a high-risk environment. In such a high-risk environment, investors ought to consider following a proven model. (That includes the ZYX Asset Allocation Model.)
Currently the model calls for holding a fair amount of cash in addition to holding on to good long-term positions. In addition to long-term positions, investors may want to focus on some short-term trades and special situations. An example of special situations is companies that are likely to be bought out. To date, 144 of our portfolio companies have been bought out or have significantly benefited from mergers and acquisitions. Please see “Here’s an evergreen strategy to make money in a volatile stock market.”
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.