Stocks recovered Thursday from three days of selling earlier in the week. As talk of a bubble in stock prices makes the rounds in the media, Fed policy remains the key indicator to watch.
Our index indicators continue to give bullish readings, unchanged from last week, as the Dow Industrials and S&P 500 continue to build on all-time highs. Consistent with the indexes moving higher, their 50-day moving averages are rising as well. For the Dow, that price is 15,550, for the S&P 500, 1,740, and for the Nasdaq, 3,860. Of course, the Nasdaq is still quite a ways from its all-time high set in the year 2000, a year that — in hindsight — marked the top of a speculative bubble.
Our internal indicators continue to confirm the bullish momentum in the indexes. The Advance/Decline Index and Cumulative Volume Index remain bullish, while the 200-day Moving Averages Index remains bearish. Also, all nine S&P sector index funds are bullish.
Not coincidentally, talk of an asset bubble in today’s market continues to make the rounds. Sound arguments can be made on both sides. The bubble side argues that Fed money-printing and artificially low interest rates are driving stock prices and corporate profits higher than they would be in “normalized” conditions. The non-bubble side argues that increasing global prosperity and advances in technology justify higher stock prices. But either way, should Fed policy change, we saw earlier this year that stock prices could struggle.
Those attempting to gauge in advance what the Fed is thinking have been active in the Treasury bond market. And the past week was not a good one for bond investors. The iShares Barclays 20+ Yr. Treasury Bond ETF (TLT) broke down and fell through the bottom of its recent trading range and is now resting at very key support at $102. That support has held three times so far this year, and it is imperative that it continues to do so. A break below that level could send TLT cascading lower, and lower bond prices translate to higher interest rates.
Only time will tell which side of the bubble argument is correct. Until then, the best course is to believe that it is foolish to fight the Fed, so buying stocks and using the 50-day moving averages as stop prices is a prudent route to take. That route can also be used for options positions. As long as the indexes are providing a bullish backdrop, continue to weight your option plays toward the bullish side.
Recommendation: Buy the Bank of America (BAC) January (2014) 15 calls (BAC140118C00015000) at $0.89 or lower. After entry, take profits if the stock price hits $16.40 or the option price hits $1.50. Exit if the stock price closes below $15.20 or the option price closes below $0.60.
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