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Market Trumped by Politics

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The historically low volatility finally ended yesterday as stocks sold off after another wave of political turmoil. The Dow lost 373-points and we saw losses of about 2% or more across the board. The lagging small caps and Transports gave up 2.2% and 3.1% respectively, and we finally saw those open gaps get filled on the S&P 500.

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The latest news that FBI director Comey had written down memos during a meeting with President Trump, and it may turn out to be unfolding an obstruction of justice charge. It came out after the market closed on Wednesday and I didn't even mention it in my commentary because, like everything else going on in Washington, the market didn't seem to care about the constant wrangling. Yesterday it took notice.

The democrats in Washington have one main goal right now, and that is to take down Donald Trump so it has been a constant barrage of accusations and Trump has given them the ammunition. Whether it was the cumulation or this one specific event, Wall Street, which had largely ignored the noise, finally gave in. The concern of course is that putting Trump on the constant defense will slow down his ability to pursue his economic agenda, and the market, et al, may have to wait longer for tax reform. Does that mean all of the post election rally will be given back?

That's my 2 cents on the situation but we've been looking at the technical action in the charts everyday and we saw those bear flags on the market leaders (small caps and Transports) and large open gaps on the S&P 500. So whether it was Washington or something else, it seemed like stocks may have just needed a reason to start to pull back.

So far this is just a pull back and filling those gaps is a good thing if for no other reason, we don't have to worry about them anymore. If it becomes more than that because of tax reform being constantly delayed, then the market may get more cranky.

The S&P 500 / C-fund gapped down and the selling didn't relent at all during the day. It was as if the someone pulled the plug after the large cap indices like the S&P, Dow, and Nasdaq refused to budge despite the political chaos going on. Yesterday that changed and we may have seen the program trading turn their switches from buy the dips to keep selling.

Taking a closer look to zoom in on the gaps, which I have obsessed about for weeks - all three of those open gaps that we have been watching (red) got filled yesterday, and the sell-off opened a new gap, and this one is now on the upside (blue). Isn't it amazing how the bottom of the post French election gap acted as the exact low yesterday?

The DWCPF (S-fund) finally relented and succumbed to the bear flag that was dragging on. There's now an overhead gap here too but we'll have to see if the bears want to continue to put the pressure on in the coming days before attempting any gap fill, but we're 90% sure it will eventually get filled. Days, weeks? months? That's the question.

The Dow Transportation Index saw a double bear flag breakdown yesterday as the 2nd small flag (purple) broke down, and now the large flag (red) is broken. The downside target for that large broken flag is about 8500 - 8550.

The EFA (EAFE Index / I-fund) fell in sympathy with the U.S. markets and that's also because of the potential hold up in tax reform. If the U.S. lowers taxes or decreases regulations, other countries would have likely followed. What helped the I-fund hold up better again yesterday was another sell-off in the dollar.

The dollar (UUP) was down 0.67% yesterday and this chart is broken. That said, it is quite extended and there are now 4 open gaps in a row that may need to get filled by a relief rally.

The AGG (Bonds / F-fund) rallied to a post-election high, filling that open gap from the day after Election Day. I still don't know what the bond market is seeing to drop yields so low, but somehow it was getting positioned for yesterday's sell-off in stocks. The question is, now that bonds have gotten back all of their post-election losses, does that mean stocks will give back all of the post election gains?

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

Tom Crowley

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S&P 500 (C Fund)
DWCPF (S Fund)
Dow Jones U.S. Completion Total Stock Market Index (^DWCPF)
EFA (I Fund)
iShares MSCI EAFE Index (EFA)
AGG (F Fund)
iShares Lehman Aggregate Bond (AGG)