After a HUGE move higher last week, this week the market digested those gains in a very productive way. For the week the C fund was up 1.79%, S fund up 0.05%, I fund down 0.01%, and the F fund was down 1.85%.

In this post we’ll take a look at the Yield Curve, Recession, a review of “Plan A”, and both the short and long term views of the TSP fund charts. There is both good news in the charts as well as reasons for caution…

The Yield Curve and Why It Matters

The Yield Curve is one of those nebulous terms that few people understand but, it’s really not that complicated. Yield means the same thing as rate or rate of return.

Let’s say you bought a 10 year Treasury bond that pays a 10% yield. If you paid $1,000 for the bond, you will receive an annual payment of $100 for 10 years in exchange for lending your $1,000 to the government. At the end of the 10 years, you get your $1,000 back. It’s an IOU with a 10% annual rate of return; pretty straight forward.

Let’s compare that to a 2 year Treasury bond. You would expect to receive a smaller rate of return on a 2 year bond because you are lending your money for a much shorter time period. Let’s say the rate on the 2 year bond was 2%. You would get $20 per year for 2 years on your $1,000 bond and get the principle ($1,000) back at the end of 2 years.

The longer the time period of the bond, the more risk and opportunity cost is associated with that purchase. That’s why you get a higher yield for longer term bonds. What happens when the market sees short term risk as more significant than long term risk? In this case, the market demands a higher rate of return for shorter term bonds. This is what happens when bond investors anticipate economic problems in the not so distant future…

When the bond market demands a higher yield on 2 year treasury bonds than 10 year treasury bonds, it is more worried about the near term than the long term. This is what it means when you hear the term “inverted or negative yield curve”. It’s an indication of an impending recession. On a chart it looks like this…

The chart below shows the 10 year yield minus the 2 year yield, from 1980 to present. Every time the yield curve drops below 0, a recession is coming within the next several months (Grey areas in the chart are recessions). A negative yield preceded each major recession since 1990 in this chart.

Since the yield curve is still positive right now, there is little fear of an impending recession in the U.S. This is consistent with our “Plan A” analysis of stock fund prices moving forward.

https://fred.stlouisfed.org/series/T10Y2Y

Recession

What exactly is a recession? The term is like the Boogie Man but, what exactly does it mean? A recession is defined as 2 consecutive quarters of decreasing Gross Domestic Product (GDP). It’s an observed slowing of U.S. production over 2 consecutive quarters. The obvious problem is that it takes 2 consecutive quarters of GDP contraction before a recession is officially recognized. The stock market, and our TSP funds, roll over long before a recession is officially identified!

A negative yield curve does not tell us that a recession is happening tomorrow but, it puts us on notice that a recession is coming. In the chart below, we can see that a negative or 0 yield curve gave us advanced warning of each of the last 3 major stock market tops that became Bear Markets (2000, 2007, and 2020).

Again, since the yield curve is not negative right now, there is little fear of an impending recession in the U.S. This is consistent with our “Plan A” analysis of stock fund prices moving forward.

Plan A

We’ve been talking about this Elliot Wave count as our Plan A for the last several months. Because the 10yr – 2yr yield curve is still positive, we should expect stock prices to continue to expand and give us a wave V.

The TSP Funds

We’ve been looking at this 2 year weekly chart of the C fund for the past couple of months. Since getting back above the 20WMA after Covid, the C fund found support at the line during each minor correction until January 2022. In January, the C fund closed below this line on a weekly basis and the 20WMA became resistance to price advance. This week, the C fund finally closed back above the 20WMA line again. In addition, the RSI is now back above the 50 line. In general, we want to be in the stock funds when the C fund is above the 20WMA and the 50 RSI line.

We want to see the C fund remain above the 20WMA and the RSI line above 50 as this rally attempt really takes hold. A weekly close below the 20WMA and 50 RSI line would cause us to question this breakout.

There is a ton of information in the 8 month daily chart of the C fund below. First, the good news… The C fund price is clearly above all 3 important moving average lines. With all three moving average lines converging, we want to see price find support above 4425 on any near term pull back. The C fund is also well above the 50 RSI line on a daily basis. We want to see the 50 RSI line act as support on any near term pull back.

And now for the bad news… The C fund has recovered exactly 61.8% of its losses from the top in January to the low in February. If this rally is a Bull Trap, the 61.8% retracement level is an excellent time for a reversal. Also, the February double top at 4600 could provide near term resistance. Finally, and most importantly, this huge price advance has come on consistently decreasing volume. We really need to see some up days on big volume to solidify this rally.

The S fund had a very productive week of consolidation. Price is still below its 20WMA and RSI is still below 50 on a weekly basis. Like the C fund, we need price above the 20WMA and the 50 RSI line to instill more confidence in this rally.

The daily price action shows a better picture. The S fund put in a triple bottom at 1800 and rallied back above its down trend line. This week price consolidated between 1950 and 2000, digesting the big gains from last week. This is very bullish price action. Getting back above 2100 will be the next major hurdle.

The I fund also had a consolidation week, finishing basically flat. The 75 level provided major support for the I fund from February 2021 to February 2022. The 75 level and the 20WMA should now act as resistance. I would expect some additional consolidation or a pull back in the I fund before it makes another run to get above the 20WMA.

On a daily chart we get a different picture. The huge recent price has move has paused over the past week. Unfortunately, as price was recovering, volume was decreasing and RSI is barely over 50. This rally looks to be topping out and will need more consolidation to push through the 75 level.

The 5 year weekly chart of the F fund gives us a long term perspective. The drop from 115 to 106 has come on increasing weekly volume and consistently declining RSI. Either the bottom is in OR the F fund likely falls to test the 100 level; the high from September 2017.

Bottom Line

The most important piece of data in this newsletter is that the C fund is now back above the 20WMA. We want to see the S and I funds get back above their respective 20WMA lines for this rally to really get going. Unfortunately, both the S and I funds are looking at serious overhead resistance and are over extended in terms of price in the short run.

I would like to see a relatively mild pull back, on low volume, to set us up for the next move higher in this rally. If we get that, I would consider reallocating to 100% stock funds. If the pull back collapses through all support on the C fund, and is on big volume, then I would consider reallocating back to the G fund in anticipation of a retest of the lows at a minimum. Our current allocation of 50% stocks and 50% G fund gives us the flexibility to respond to whatever price does on the next pull back.

Is this a Bull Trap? We should get the answer within the next week or two…

Have a great week!

Jerry