What if the Federal Reserve gave up raising interest rates?

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By Joe Duarte

I’m definitely not triple mortgaging my house to buy stocks on margin. But I’m sprucing up my shopping list and recharging my hurdles at the same time – just in case.

Chaos, by definition, is predictable and unpredictable. That’s why it’s no surprise that stocks rallied strongly on 2/25/22 after bear market signals were triggered the previous day due to news of Russia’s invasion of Ukraine. This is because the algorithms are betting that the Fed will backtrack on its promise to raise interest rates as the situation in Ukraine unfolds.

Of course, there is no guarantee that such a thing will happen. So stocks could reach new lows just as easily as they could take a huge jump over the next few days. But that’s the bet of the moment. And they may be right. So, as traders, we have to be ready to adapt. All of this is worth exploring the stakes for investors as this totally unpredictable situation unfolds.

Meanwhile, as I explain in detail below, the New York Stock Exchange’s Advance-Decline line (NYAD) may have delivered a bullish technical divergence. So what’s the bottom line? If that was the bottom, maybe it’s time to buy again. We should definitely know more in the next few days.

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A recap of what the Fed seems to be trying to do is in order.

The short version is that the Eckles building gang drove stock prices down before raising interest rates so they had to offer fewer rate hikes. In other words, the Fed does not want a deep recession, rather a pause in the economy.

Their concern, and it is valid, is that since the stock market is the lifeline for those who spend money and keep the economy afloat (the MELA system), a deep wound to the wallet will suffice.

For those unfamiliar with the acronym MELA, M stands for Markets, E for Economics, L for Life Decisions, and A for Algos. When the stock market is up, the economy tends to grow as people decide to spend money. The algorithms, the artificial intelligence that is everywhere only accentuate the trend.

Unfortunately, MELA’s spending habits are so tied to the stock market that even a modest pullback can trigger a bigger-than-expected downturn in the economy, as this subset of the population, who depend on the state of their 401 (k), their IRAs and trading accounts (Bitcoin included) are adapting quickly.

This is because the MELA crowd is well plugged into the markets but is also in debt. As long as the market is up, debt is only part of the financial plan.

Unfortunately, if the Fed crushes the market, incomes fall, debt becomes harder to repay, and other areas of spending will suffer – mortgages, car payments, dining out, weekend shopping sprees, Netflix subscriptions. .

The world of EBITDA and the connection to MELA

The truth is that the MELA phenomenon is a mirror image of the business EBITDA model (earnings before interest, taxes, depreciation and amortization). This is the term companies use to show investors how much money they would make if they had no expenses.

EBITDA companies, usually growth companies, are successful if they can increase their revenue and pay their debt. But even the most capable management team has to make the transition from EBITDA (fictitious earnings) to actual earnings.

The best modern example of how this works is to study the rise of Amazon.co.uk (NASDAQ:AMZN)which in its infancy was the ultimate EBITDA company, and how it grew into the profitable giant it eventually became.

The problem with EBITDA is that when revenue drops, the debt is still there. Thus, the company must redeploy its declining revenues to repay its debt. This takes money away from research, development, capital expenditures, and employee retention and recruitment.

There’s no doubt that EBITDA works on Wall Street, since companies can simply sell more bonds or tap into their near-infinite lines of credit. It may work much longer than expected. Consider emerging biotech stocks.

But in the MELA world, where people live, when the stock market drops, credit card and mortgage payments don’t go away. And lines of credit, if there really are any, are limited. As a result, in the MELA universe, reduced revenue due to falling stock prices must be redeployed and someone or part of the spending plan suffers the consequences.

This group’s concern is evident in the latest consumer confidence survey from the University of Michigan.

So now you can see why the Fed is now in a heap of trouble, and why the algos are betting that Ukraine will give the central bank a break in its quest for higher rates.

Market breadth rebounds from near-death experience as bullish divergence emerges

The Advance-Declin line of the New York Stock Exchange (NYAD) finally turned around after a dismal few weeks. Of course, it’s hard to know if this is the ultimate bottom or not.

There is, however, the possibility of a bullish divergence, as the NYAD has reached a new low, but the RSI has not reached a lower low from its most recent low. This suggests that we may see the bottom of the panic and prices may be stabilizing now.

But one thing is certain. NYAD is very oversold which, combined with the reversal of the CBOE SPX Volatility Index (VIX)which measures the volume of put options, there may be some hope.

A rise in the CBOE SPX Volatility Index (VIX) signals that the volume of put options (bet that the market will go down) is rising. What follows when the volume of put options increases is that the increase in selling volumes causes market makers to sell put options and simultaneously hedge their bets by selling stocks and contracts at stock index futures.

NYAD Chart

Stock charts

The S&P 500 (SPX) remains below its 200-day moving average, but it is back inside the Bollinger bands, which means there is now a chance that a reversion to the mean, a test of the line of 200 days is in sight.

On the equilibrium volume (VOB) is still a bit soft, but the accumulation distribution (ADI) suggests the rally is short covering at the moment. The index moved back into the trading range between 4300 and 4650 after a decisive move below 4300, as I noted, could occur, caused prices to fall rapidly. Yet, just like with NYAD, we see that the prices are lower and the RSI is lower.

SPX Chart

Stock charts

the Nasdaq 100 index (NDX) remained below its 200-day moving average, but also shows a bullish divergence with a new low and a higher on the RSI.

NDX Chart

Stock charts

the S&P small cap 600 (SML) is exhibiting a similar potentially bullish technical divergence.

SML CHART

Stock charts

Originally posted on MoneyShow.com

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

Leslie M. Gill