Stocks were mixed on Tuesday with small caps leading again, but the S&P 500 opened flat, rallied up to make a new all-time high, then closed 36-points off that high.  It could have been a negative reversal day except that it also closed 20-points above its lows of the day, so there was a lot of choppy action in front of today's interest rate decision.  A rally in the dollar weighed on the I-fund yesterday, and bonds (F-fund) were down as yields ticked higher.

Daily TSP Funds Return More returns

The "Bond King", Jeffrey Gundlach has forgotten more about the bond market then I'll ever know, and he believes the Fed will cut by 0.50% today, so how can I argue?  I did hear elsewhere that since 1994, the Fed has not started an easing cycle with a 0.50% cut unless it was a non-scheduled, emergency cut during some level of crisis.  It's been done before but it seems odd to start cutting rates aggressively when the stock market is basically at its highest level ever.

We got a new Q3 GDP estimate from the Atlanta Fed at +3.0%.  That's far from recessionary so again is 0.50% needed?  There are some economic concerns that are less noticeable than GDP in the labor market and manufacturing that might warrant the larger cut.

As I mentioned yesterday, a 0.50% cut may suggest that the Fed is worried about being behind the curve and waited too long.  Do they want to admit that and potentially scare the market with that sentiment, or worse make a large cut in front of an election and appear political? 

We've talked often about the 2/10 year yield curve which has been steepening and recently un-inverted for the first time in over two years.  And while we see 3% GDP in Q3 estimates, did you know that the 3-month yield is still paying more than all long term bonds, meaning that 3-mon / 10-yr yield curve is still very much inverted?  Again, that smells of recession. 

               


Here's the 2/10 year yield curve, which has finally recaptured the zero level meaning the 10-year yield is back to yielding more than a 2-year Treasury.  That tends to happen when the Fed starts cutting rates, and they tend to cut rates when the economy is vulnerable.

         

And above is the 3-month / 10-year yield curve which is still very much inverted, meaning a 3-month bond is paying more than a 10-year Treasury.  That is not normal action even though it has been that way for a couple of years now.

Here's a long-term view of the 3-month bond yield and I've highlighted the prior times that it went from inverted to un-inverted.

       

It hasn't even gotten to un-inverted yet but history suggests the stock market may not like it when it happens.  Or, another way of saying it is that it tends to happen when the stock market is not doing well.  Is the dog going to wag its tail, or will the tail wag the dog?

It's time for the Fed to announce their decision on interest rates.  With investors split between 0.25% and 0.50%, many will be surprised or disappointed.  The Fed's decision usually comes at 2 PM ET so that's when we should see the fireworks begin.

If we look at the charts of the TSP stocks fund (bottom section) we see that while we have had a decent rally since the early August low, the indices are basically where they were two months ago at the July peak.  It's been a long consolidation that could be the springboard for a breakout to new highs, or the Fed could spook Wall Street and perhaps keep the indices in consolidation during this historically weaker 2-month period for stocks.

Unfortunately for us TSP'ers, any big moves in the market caused by the Fed will come well past the Wednesday IFT deadline so we'd be guessing making a move early today, and if we wait until after the Fed decision to react, the IFT won't take effect until COB on Thursday, meaning we wouldn't be in the new funds until Friday's open.  That's a lot of trading in between, and a pretty big disadvantage for us.

One more thing, there is often a change in direction, or a least a possible big move in one direction or the other in the market the week following a quadruple witching expiration, which is this Friday. 
 

The S&P 500 (SPY / C-fund) hit an official double top as it stalled 1-point above the July high before pulling back.  That's normal action but the question is whether we get a meaning full pullback from here, just a stall. or will the Fed pop this above the highs?  Watch out for a rug pull scenario where it breaks out or breaks down with a big move, only to reverse later in the day or even the next day.  Emotions will be high and you can't always trust the initial reaction.

        


The DWCPF (S-fund) of course loves the idea of lower interest rates, but this too is hitting some resistance that could precede a major breakout, or a healthy pullback.  That red gap is still open near 2080 and that would be a nice thing to see filled in the short-term and could be a great buying area if someone has cash on hand.  That's about 3% below the current level.

       


The I-fund will be changing to another tracking index and we won't be able to use EFA as a tracking ETF.  I'm looking for an ETF that will be similar to the EFA, using MSCI ACWI IMI ex USA ex China ex Hong Kong Index, which is the new approach.  They are taking out China and Hong Kong and adding countries like India and Brazil.  Here's more information from tsp.gov.

They said they were going to make the switch slowly this year knowing how much money needs to be moved, and it's not easy moving huge sums of money in the market without influencing the action.  The EFA suggests a loss of 0.56% yesterday while, what I will call the "ex USA ex China ex Hong Kong Index" for lack of a better name, was close to flat on the day.  Let's see what return they give the I-fund for yesterday (I am wring this before it got posted.)


BND (F-fund) was down slightly but it is still trading near the recent highs.  The trend obviously favors the bulls, but is this getting overly extended?

Thanks so much for reading!  We'll see you back here tomorrow.

Tom Crowley


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