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Calm after the bull storm

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3/15/12

Stocks took a break yesterday after the 200+ point gain on Tuesday. The indices were mixed as the Dow and Nasdaq saw small gains, while the S&P 500, small caps, and particularly the Dow Transports, all lost ground.


For the TSP, the C-fund was down 0.12% yesterday, the S-fund lost 0.74%, the I-fund fell 0.65%, and the F-fund (bonds) dropped 0.57%.

The S&P 500 posted a rather flat day yesterday, which could be a refueling day after a pretty good 5-day run. As I mentioned, the bullish line in the sand may be in the area of 1371 where the 2011 high and the new rising support line are about to meet.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

The Transportation Index pulled back hard yesterday losing 1.4%, but found support in a key area making the rest of this week important technical analysis-wise, as the top of the old descending trading channel meets the 20-day EMA, meets the what could be a new rising trading channel - although the rising angle is pretty steep.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk


Let's talk about bonds again as we are seeing something very interesting happening in the bond market. The yield on the 10-year T-note broke out on Tuesday and yesterday we saw an even bigger move higher. It went to 2.27% which is above the 200-day EMA, and it filled the gap left open last October rather nicely.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk


We know that bond prices (and the F-fund) move inversely to bond yields. Taking a look at the ETF (exchange traded fund) TLT which is a bond price fund, you can see that it may be breaking down, although it did find support at the 200-day EMA after filling its open gap from October. There were also gaps left open in both
price and yield, after yesterday's big move.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk


This could be an area of support for bonds, but if the market believes the Fed and the economic data which is indicating some strength in the economy, high yields and lower bond prices would make sense.

So why do bond prices move counter to yields? I don't believe we've talked about this for a long time so I hope this helps those who may not have known. I will make it very basic because in the real world there are many influences such as yield to maturity, but let's keep it simple.

Bonds have a price, and a rate of return. At "par" a bond yield is equal to the interest rate.

If you buy a $100 bond that has a rate of 5%, then the yield is 5%.
That's a return of $5, and $5 / $100 = 5%.

If you were able to buy this $100 bond for $50 for whatever reason, it still has an return rate of 5% of $100 or $5.
You are getting a $5 return on this $100 bond, but since you only paid $50, the yield is now 10%: $5 / $50 = 10%. As the price of the bond went down, the yield went up.

If you had to pay $150 for this $100 bond, it would still have a return rate of 5% of $100 or $5. You are getting a $5 return on this $100 bond, but since you had to pay $150, the yield is only 3.3%: $5 / $150 = 3.3%. As the price of the bond went up, the yield went down.


We have seen 10-year T-note yields go from nearly 4% a year ago, down to the recent 2% and lower of late. That is why the F-fund had done so well in 2011 leading all of the funds with a 7.9% gain. If we start seeing the yield move back up to 3% or higher this year, you will see the F-fund underperform in 2012.

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


Administrative Note:
Deadline is 12:15 PM ET today... The TSP Talk March Madness Contest has Started!

Tom Crowley


The legal stuff: This information is for educational purposes only! This is not advice or a recommendation. We do not give investment advice. Do not act on this data. Do not buy, sell or trade the funds mentioned herein based on this information. We may trade these funds differently than discussed above. We use additional methods and strategies to determine fund positions.

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Comments

  1. crommie's Avatar
    But doesn't the Fed want to keep the rates low to help with the recovery and therefore keep the price high? Or in other words, should we expect the Fed to step on this breakout/breakdown in the the bond market to get rates back down below 2%?
  2. tsptalk's Avatar
    They did, and they may again, but in their recent 'testimony' they were indicating enough confidence that the bond market finally sold off. Maybe enouygh was enough when it came to cheap money and killing the dollar. But we'll have to see if it sticks.
  3. Birchtree's Avatar
    Remember, bonds operate off of negative psychology....the Fed has no control of the long end of interest rates - they leave that up to the bond vigilantes. Rates will rise and stocks will also rise until they get to 7%.
  4. tsptalk's Avatar
    A little follow-up on the Dow Transportaion chart above...

  5. Birchtree's Avatar
    Coal is acting better today and that is impacting the trains - it's going to be all about exports to China and India.

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