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TSP Talk - Will stocks rally if interest rate hikes are done?

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Stocks sold off on expiration Friday, giving back the solid gains it had accumulated during the week. The Dow lost 289-points and this time it was big tech that led the S&P 500 and Nasdaq on the downside, while small caps outperformed, although it was no picnic for them either on Friday. Stocks are still having a very strong year so is this just the typical fall shake out before the typical 4th quarter rally - especially if the Fed is done raising interest rates, or is there something more serious going on here?

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Last week we saw the Yield on the 10-Year Treasury go up, the dollar made a new multi-month high, and oil is now over $90 a barrel. These are all headwinds for stocks right now, yet stocks were up until the quadruple witching expiration sell off on Friday, which has a history of some shenanigans as expiring futures, options, derivative contracts expire at the close and price determines if they have value or are worthless, so there's a lot of tugging and pulling around target prices in these contracts. Now that it is behind us we could see which way stocks are really trying to go.

Even with that major sell off on Friday the S&P 500 (C-fund) was down just 0.13% for the week, small caps (S) were down 0.49%, and the I-fund, with the help from the ECB, gained 1.4% for the week. So while we are seeing mounting issues, the stock market has held in there fairly well despite still being in the midst of a moderate pullback off the late July highs, but also well off the August pullback lows.

Unfortunately for the bulls post options expiration week in September is historically a poor week for stocks. That could be why, over the last several years, the Friday during expiration week has been down - perhaps some selling to front run this week's negative historical bias this week? Of course when everyone is in agreement on something - like this week is bad for stocks - don't count out the possibility of the market proving the masses wrong.

The good news is, investors are getting more confident that the Fed is done raising interest rates. The probability for another rate hike here in the U.S. over the next two FOMC meetings (this week and early November) has dropped from 44% just a week, to 27% currently. The ECB (Europe) has already suggested that they may be done raising rates.

The bad news may come when they start cutting rates. That doesn't sound right, but that's the way it goes. If they stop raising rates it may be an indication that inflation is under control, but also that their rate hikes are starting to impact the economy negatively. The reason they would actually cut rates would be if the economy started suffering, and predictions of a recession are all over the map right now.

The 2 year vs. 10-year Treasury yield curve is still inverted, but it is making another attempt at steeping again. That means the 10-year yield is getting closer (moving up) to the 2-year yield, which is currently still just above 5.0%, while the 10-year is up to 4.3%.

I've shown this chart a few times but the point bears repeating: If the Fed is cutting interest rates the yield curve will likely head up quickly. Lower interest rates sound great but the stock market is usually peaking about the time it happens as the Fed would be trying to stimulate an economy that has weakened, if not gone into a recession already. Here's some examples of when an inverted yield curve started to steepen again. Each time it was the Fed cutting rates to try to help an economy that was in trouble.

The Fed does not appear to be considering any rates cuts any time soon so perhaps we are a long way from the yield curve steepening sharply, and maybe this is backwards thinking, but historically the market remains firm until the 10-year yield starts to overtake the 2-year yield at a rapid pace like in 2000, 2007, or even 2020, even though it never officially got inverted that year, but it was on its way.

As I pointed out last Monday, the weekly chart of the S&P 500 had a bullish repeating pattern going, and until Friday's sell off, it looked like it was going to happen again. Where the chart came to rest on Friday is interesting because it is either right on support that could trigger some buying this week, or it is about to break down and perhaps test the next logical support level of 4374 (20 week average) or just above 4300 where the market peaked in August of 2022. Otherwise, a bounce off support could push it closer to 4600 in the coming weeks. Seasonality would suggest the former is more likely, but this longer-term chart actually doesn't look too bad right now.

The daily charts of the small caps, the S-fund and Russell 2000, have been struggling and don't look as good as the S&P 500 chart, but the longer-term weekly chart suggests it still has an out (poker term.) That out would be to have the longer-term moving averages hold here and bounce back toward the overhead resistance. These charts been consolidating sideways for a long time and a big move is eventually going to come out it, but which way? Being above those moving averages may give the advantage to the bulls, but the huge bearish flag formations favor the bears and a breakdown. The 4th quarter should be interesting for the stock market.

I don't know how much the UAW strike against the car companies is going to play out or impact the stock market, but like the potential for another government shutdown, they could end at any given time so it's tough to take into consideration.

We don't have any major market moving economic data being released this week but there is an FOMC on Tuesday and Wednesday of this week. While there is no rate hike expected, getting some insight into what they may be planning next, could move the market this week.

The S&P 500 (C-fund) got slammed on Friday and that gave back five days worth of gains. A short-term support line was broken and the 50-day EMA is getting tested now. This doesn't look that bad and there are some indicators that confirm possible strength, but we know seasonality is on the side of the bears, especially this week, and some of the other broader index charts are not looking good.

DWCPF (S-fund) is one of those that isn't looking as good as the S&P 500, and in short-term this looks like it wants to retest the 1720 neckline area, but I'll remind you again that sometimes the neckline in inverted H&S patterns holds in bull markets and this is still considered a bull market.

EFA (I-fund) held up better than the US funds on Friday, but after a morning rally above the 50-day EMA, this rolled over closed just below the average again. This doesn't look great but perhaps the call by the ECB last week to stop raising interest rates can help it turn back up again?

BND (Bonds / F-fund) broke down from that small bear flag on Friday and may be ready to fill that open gap. This is not a great looking chart but it could hold near the lows if the Fed signals any dovish bias in this week's FOMC meeting toward interest rates.

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

Tom Crowley

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S&P500 (C Fund) (delayed)

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DWCPF (S Fund) (delayed)

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EFA (I Fund) (delayed)

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BND (F Fund) (delayed)

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