TSP Investing in 2018

2018 Road Ahead for TSP Investors

Happy New Year!

First things first: I have changed my TSP allocation (and transferred existing balances) to 50% C Fund, 50% I Fund. More on that below.

In this post I will run through a few of the investing rituals I go through at the beginning of every year, take a quick look back at 2017, explain why I am making the allocation change, and talk about the risks and potential for the year ahead.

In the next few days, I hope to get out additional posts about (1) what I will be investing outside of the TSP this year and (2) my recent adventures in crytocurrency speculation.

I am going to try to be a bit less verbose this year and keep these posts to a more manageable size. That will help readers get through them, and will make it more likely that I will get them out on time (particularly as we get closer to the baby arriving). If you find that means I have skimped on detail and you have questions, please don’t hesitate to ask in the comments or on the message board.

And before we get into the substance, thanks very much to all of you who helped the website and community grow in 2017 by sharing with your colleagues, sending me suggestions and making donations to defray expenses.

Tasks for the New Year

Adjust TSP contributions: Top of the list was adjusting bi-weekly TSP contributions on the TSP.gov website to maximize matching and make sure I am able to invest the full amount. The annual limit was raised by $500 to $18,500 for 2018. There is no one-size-fits-all number to maximize contributions because there are either 26 or 27 pay dates in 2018, depending one which processor services your agency:

NFC: 27 pay dates = $686
Interior: 27 pay dates = $686
GSA: 26 pay dates = $712
DFAS: 26 pay dates = $712

Back-door ROTH IRA: Next up was opening a back-door Roth IRA to continue to put as many of my investments into tax-advantaged accounts as possible. (Please don’t confuse this investment account which is completely separate from the TSP with the TSP Roth option). In many respects, a Roth IRA is a better vehicle for your money once you have contributed enough to your TSP to capture all the employer matching you are eligible for. (Of course if you make less than $120,000 for single filers and $189,000 for married couples filing jointly, you can skip the back-door part of this and just open a Roth IRA directly.)

It sounds complicated, but if you already have a brokerage or Vanguard account it will take about 15 minutes from start to finish. (If you don’t already have investment accounts outside the TSP, I strongly recommend Vanguard.com).

  1. open and fund a traditional IRA (select non-deductible on the form)
  2. once the account is funded, convert the new IRA account to a Roth IRA by submitting the brokerage’s form or calling customer support
  3. result: you now have $5500 to invest on which you will pay no taxes on gains, you can withdraw your principal (the $5500) at any time with no penalty, and you can withdraw gains prior to age 59 1/2 to buy a home or for higher education expenses (which is why you always fund your Roth IRA before a 529 account).

If you have the money to do it, you can also still do the same thing for tax year 2017 until April 15, 2018, so you can get your Roth off to a five-figure start.

*Note that if you have existing traditional IRAs which were funded with pre-tax money (deductible), this probably isn’t for you. See the comments and link below. (Thanks Steve!)

A Quick Look Back at the TSP in 2017

First, let’s take a quick look back at 2017. I can’t take credit for it, but I am pretty happy with the way things went:

C Fund: 21.82%
S Fund: 18.22%
I Fund: 25.42%
F Fund: 3.82%
G Fund: 2.33%

If you look back at last year’s post (A Look Forward at TSP Investing in 2017), you will see that I got a few things right (the C Fund outperforming all of the other domestic funds, the US avoiding recession, and the circus in Washington, DC not having a real impact on the stock market). And a few things wrong (the market grew much more strongly than the “mid-to-high single digit returns” I predicted, we saw a lot less volatility than I expected, and the TSP I Fund didn’t fall apart as a result of the UK’s vote to exit the EU).

In my defense, I did say in last year’s post that I thought the I Fund could potentially perform as well or better than the C Fund, but that their valuations were similar so the added risk didn’t make sense to me.

But I’m not really feeling defensive – last year turned out pretty well.

An interesting aside about that 21.8% return for the C Fund – that is almost exactly the average return of 21.5% for the S&P 500 in bull market years. We all know by heart that the S&P 500’s average annual return is about 10%, so we make that our benchmark and predict slightly higher for good years and slightly lower for bad years. I do it too. But that isn’t at all what has happened historically – we should expect much, much higher returns in bull market years, and much, much lower returns in bear market years. And that’s why it is so important to be out of the market for as many of those bear markets as we can.

A Look Forward at 2018

The stock market goes up two years out of three. Eliminate the years when the US is in recession and it gets much better than that. All indications are that the US and other developed markets will avoid recession in 2018.

Without a recession, the stock market will in all likelihood end the year higher than where it started. As with last year, from a price to earnings ratio perspective, right now the US stock market doesn’t have a lot of room to grow (meaning the market’s current P/E is well above average), so it is hard to imagine that we will do as well as we did last year. But that’s what I said last year and the market powered right through those worries. The corporate tax cut could give a little bit of relief to those high valuations as that gets factored into earnings over the next few quarters.

I certainly expect that we will see more volatility this year than we did last, which was extraordinarily smooth. It is almost as if so many outrageous things happened in 2017 that nothing mattered and everything which typically would have caused the typical 5-10% declines was ignored.

As at the beginning of every year, I will confidently predict we will see four or five 5% corrections, and probably a 10% correction at some point (because that happens pretty much every year). With history as a guide, I am convinced the timing of those corrections isn’t predictable, and that the market will recover and move higher in each case within a matter of weeks. In 75% of years in which the market goes up, the market drops below break-even during the first quarter.

So with all of that together, I think there is an excellent chance we will see a 5% to 10% correction at some point in the next two months. But I won’t try to game that – if I held money out and waited for a drop, the market would inevitably go on a strong run and leave me behind.

Risks to the TSP Stock Funds in 2018

Trump dominates all talk of risks to the global economy right now with his rhetoric on trade, particularly with attacks on China (our #1 trade partner) and NAFTA (our #2 trade partner (Canada) and #3 trade partner (Mexico)). But the markets appear to be tuning the posturing out and looking at the actions coming out of DC. Or rather the inaction – while the US withdrew from talks for the Trans-Pacific Partnership, it hasn’t touched any of the existing trade agreements we have in place. Imports from China increased by $32 billion in 2017, and imports from Mexico and Canada soared as well.

It is certainly possible that the administration will slap tariffs on a few Chinese products to rally the base or benefit a favored industry, but the stock market is the one thing they can really point to as a success amidst all the other turmoil, so I don’t think it is likely they will take a chance on putting a stick into the spokes by pursuing real change in that area.

So which TSP fund?

I believe the I Fund is going to be the strongest performing fund in 2018 on the back of Europe (minus the UK) and Japan for the following reasons:

  • Dramatically cheaper relative valuations (C Fund is at 22.87, I Fund is at 16.75)
  • In contrast to the US, Europe is earlier in their recovery, economic expansion is accelerating, and unemployment has room to fall.
  • Supportive central bank policies – the ECB says monetary stimulus will continue until at least September and the Bank of Japan appears unlikely to change targets until 2019, whereas the US Federal Reserve is actively raising interest rates.
  • Declining political uncertainty in Europe, both within countries as well as internationally on the Brexit front is leading to greater business and investor optimism.
  • A very competitive euro helping exports.

On the domestic side of the house, large cap stocks (the TSP C Fund) will typically outperform small and medium cap stocks (the TSP S Fund) at this stage in the business cycle. Last year I got into a long discussion about the relative valuations of the C Fund and S Fund before making the decision to stick with that historical trend, but right now the weighted average P/E ratios of the C Fund and S Fund are within 0.4% of each other so that is not a factor.

Small and medium sized companies may benefit somewhat disproportionately from the tax bill because they are actually paying something close to the listed tax rate, whereas the effective rate of the huge multinationals which make up much of the TSP C Fund is much lower. But I don’t see that potential advantage outweighing the large cap’s historical outperformance in this phase of the business cycle.

It’s also worth noting that I have a sizable share of small/mid-cap ETFs in my other investment accounts, so S Fund equivalents are well represented in my overall portfolio if they do take off. Everyone’s circumstances are different, so someone who doesn’t have exposure to that sector of the market might put more thought into allocating some of their allocation to the S Fund than I did. Even if I didn’t own those S Fund equivalents, however, I would probably not be in the S Fund right now – I don’t still own these small cap funds because I think they will outperform large caps, but rather because they are in regular (non-tax advantaged) accounts and if I sell them I am going to have to pay a lot of taxes on my gains.

Conclusion: I believe that the I Fund will outperform the C Fund over the next twelve months, but not with enough conviction to go to 100% I Fund. When I was younger I might well have gone all-in on the I Fund in these circumstances, but perhaps I am feeling a bit conservative under the weight of impending parenthood and so have set my TSP contributions and conducted an inter fund transfer of existing balances to 50% C Fund, 50% I Fund.

Please don’t ever forget that these allocations are based on my circumstances and the strategy which I have chosen to employ. Your circumstances may be very different and my strategy may not work, so I encourage everyone to read widely and consider a range of different viewpoints before making investing decisions for themselves.

Recommended Reading

If one of your New Year’s resolutions is to get serious about making smart investing decisions, the following are the three essential books I would recommend:

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

A Random Walk down Wall Street: The Time-tested Strategy for Successful Investing

The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor (Columbia Business School Publishing)

Coming Up

In my next posts I will find some time to talk about how I see investing outside the TSP in the coming year as well as discuss my recent limited foray into cryptocurrency gambling.

In the meantime, I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

December 2017 TSP Allocation Update

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

12/10/2017

Welcome back for the last update of 2017.

This month I will write briefly about a few items of interest for Feds and investors, including the impact of the pending corporate tax cut bill, Bitcoin mania and the spending bill, then run through the economic numbers from November.

First up though, I want to again thank the folks who donated to support the site since my last update. I have big plans for the site in 2018 and those donations will make that a lot easier.

Bottom line up front: I will be sticking with an allocation of 100% TSP C Fund in both my existing balances and new contributions this month. That could change in the months ahead as I look again at international markets as we start the new year, and give some consideration to the S Fund as well.

Thrift Savings Plan Fund Returns

The stock market continued to move up nicely in November:

  • TSP C Fund:  3.07%
  • TSP S Fund:  2.90%
  • TSP I Fund:  1.06%
  • TSP F Fund:  -0.11%
  • TSP G Fund:  0.19%

And some pretty spectacular results for the TSP Funds year-to-date (through 12/08/2017):

  • TSP C Fund:  20.71%
  • TSP S Fund:  16.88%
  • TSP I Fund:  22.55%
  • TSP F Fund:  3.61%
  • TSP G Fund:  2.18%

In the News

Before I continue in this section, let me repeat my disclaimer that this is a strictly non-partisan blog and I do not ever favor one candidate or party over another here. To the extent that I am talking about “politics”, it is for the purpose of explaining how what is going on in the political world effects my investment decisions. My opinions about the impact of particular policies on the economy or the stock market do not necessarily mean that I either support or oppose those policies (in many cases I support polices which are not good for my individual bottom line). If I poke fun at your chosen one, please don’t take it personally, I make fun of everyone. If you still get offended after all of those disclaimers, your time may be better spent sounding out the words on another website.

The Corporate Tax Cut

The Senate’s tax bill and its implications are way too complicated to cover in a paragraph or two, but a few quick points: (1) because it was so hastily written and so full of errors (retention of the Corporate AMT at existing rates, for example, actually raised corporate taxes by $189 billion, and some provisions as written would encourage business to move operations overseas), the House couldn’t just pass the Senate bill. Instead, it had to go to conference committee. And what will come out of there is still very much up in the air. (2) But unless major changes are made to the bill, there is no “middle-class tax cut” in this thing – any benefits which people at our salary levels accrue initially will time out and go away over the course of a few years. Nearly all benefits will go to the very wealthy.

Impact on housing markets will likely be the most notable effect because of the focus on capping deductions which benefit homeowners (a limit to deductions on $10,000 in property taxes and mortgage interest on only $500,000 of debt instead of the current $1 million) and limiting the number of tax payers itemizing deductions. Estimates are that tax bill would cut 3% off home prices nationally, but of course that would be spread very unevenly. The greatest impact would be in the Northeast, Chicago area, and California, with the very worst hit areas like Manhattan and Essex County, NJ, seeing up to a 10% drop in prices. I think actual declines are unlikely in most markets, instead prices will flatten for a year or two before resuming upward trends, but with an end result that prices will be lower than they otherwise would have been.

Impact on the stock market may be largely priced in at this point. As lower taxes are realized in quarterly earnings, that will give some relief to the high valuations we are seeing currently and give the market a little more room to the upside. There are arguments on all sides for which TSP fund might see the greater benefits. Small caps (the TSP S Fund) may see a slight edge because they do a higher percentage of their business domestically and therefore the US tax rates are more important to them. But the large caps (the TSP C Fund) are more likely to have huge cash hoards overseas which they will be able to repatriate at a lower rate, so those companies should also see a bump.

The Fed

Markets appear happy with the selection of Jerome Powell as the replacement for Janet Yellen as the next Fed Chairman. Powell is seen as likely to continue Yellen’s policies to the degree possible. A number of other openings on the Board of Governors will, however, allow the possibility that more members with different views could stir the pot over the next term.

In the short run, I (along with absolutely everyone else) expect the Fed to raise rates 1/4 point next week. After that, I believe they will hold off until March before raising again. Both of those moves are expected and should have no impact on the market.

Government Spending Bill

Congress averted a shutdown on 12/8 by passing a spending measure to keep the government open until 12/22. I frankly don’t believe that they will be able to reach an agreement on both the tax bill and the spending bill before Christmas and we will see another continuing resolution pushing the budget until February. I expect a bit more brinksmanship this time around, however, but even a short shutdown would be unlikely to have more than one or two day impact on the market.

That said, it has been a very long time since we have had even a 3% correction, so a lot of nervous types will be looking for any excuse to pull out and we could see a very modest correction based on any sort of bad news at any time.

This budget process will bear close watching, however, as proposals coming in included higher contributions for FERS annuities (effectively resulting in an average $5000 pay cut for Feds), stripping COLAs from annuities after retirement (which could cost some Feds hundreds of thousands of dollars over the course of their retirement), and other nasty provisions.

The Mueller Files

The investigation into Russian interference with the 2016 Presidential Election continues apace with the guilty plea of Michael Flynn. I don’t know anything more than what is in the papers, but can guarantee Mueller didn’t assemble a dream team of prosecutors to extract a plea to one count of False Statement from Flynn. Flynn was the National Security Advisor for only 24 days, but he was part of the Trump campaign from early on and was a principal advisor with regular contact with senior members of the campaign and people very close to the President. His cooperation will open up a dozen avenues of investigation and the Special Counsel investigation is going to keep going for a long time.

As I have mentioned before, however, that really shouldn’t have an impact on our TSP investing unless we reach the point of a constitutional crisis.

Bitcoin

Bitcoin Thrift Savings Plan Allocation GuideI still don’t like it, still don’t see any use for it beyond speculation, and still think it is going to crash and wipe out a lot of people who are buying in now.

To be clear, blockchain technology is awesome and will be used in many applications in the future. I’m just not convinced that a crypto currency with nothing standing behind it is the use which will go mainstream.

I first wrote about Bitcoin in December 2014:

I don’t like Bitcoin as an investment because an asset derives its value from either an ability to generate income (earnings) or through some intrinsic value. Anything else is speculative value. Scarcity is what makes something which has intrinsic value worth something, but scarcity alone does not convey value. The alleged purpose of Bitcoin is to create a currency which can be used to conduct transactions inexpensively and without government oversight – to buy and sell things. But that’s not what is happening. Instead, the overwhelming majority of Bitcoin transactions are speculative trades – people who are buying because they think the price is going to go up from people who are selling because they think the price is going to go down. They aren’t buying a product or paying for a service, they are just exchanging one (real) currency for one which exists only in computer code. Most of the people who own Bitcoin have never used it to buy something and probably never will. The futurist in me sees lots of different platforms for conducting transactions efficiently and privately, but this imaginary currency is not one of them.

Bitcoin has three big problems in my opinion:

  1. It is a purely speculative play with no underlying value, so at any point the market can decide to value it at pennies. (For what it is worth, I don’t think that is likely anytime soon, but neither do I see broad adoption.)
  2. The “rules” which control Bitcoin can be changed at any time, so the number of Bitcoin could be increased by a factor or two or three or 100 with obvious results to value.
  3. Bitcoin is not secure or insured, and there is a very real possibility of having your Bitcoins just disappear through fraud – 7% of all the Bitcoin in the entire world went poof during the Mt. Gox debacle, and I can’t imagine that will be the last time something happens along those lines.

All that said, if anyone wants to support the TSP Allocation Guide with a Bitcoin donation, I will set up an account faster than Rolling Stone fact-checks a story.

A single Bitcoin was worth about $400 when I wrote that. Today it is trading at $16,680 – a roughly 4000% gain. I wish I was smart enough for speculating. And I did finally set up that Bitcoin wallet: 1A3H2ieHRvnW7RSohuMW9ZYpcMHc3YRYXi

November’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

Total nonfarm payroll employment increased by 228,000 in November, and the unemployment rate was unchanged at 4.1 percent. Employment continued to trend up in professional and business services, manufacturing,  and health care.

The change in total nonfarm payroll employment for September was revised up from +18,000 to +38,000, and the change for October was revised down from +261,000 to +244,000. With these revisions, employment gains in September and October combined were 3,000 more than previously reported. After revisions, job gains have averaged 170,000 over the last 3 months.

Taking a look at the unemployment rate over the course of the year, you can clearly see that we are at the natural rate of unemployment and further improvements in the rate are unlikely. So we focus much more on wage growth at this stage in the business cycle.

unemployment rate 2017 through November

 

In November, average hourly earnings for all employees on private nonfarm payrolls rose by 5 cents to $26.55. Over the year, average hourly earnings have risen by 64 cents, or 2.5 percent. That’s not impressive, but there was some good news as we are seeing a bit of a move from part-time to full-time jobs.

I obtain this data from the Bureau of Labor Statistics.

Purchasing Managers’ Index (PMI):

As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The November PMI reading of 58.2 is a very strong number:

Manufacturing expanded in November as the PMI registered 58.2 percent, a decrease of 0.5 percentage point from the October reading of 58.7 percent.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the November PMI indicates growth for the 102nd consecutive month in the overall economy and the 15th straight month of growth in the manufacturing sector.

The past relationship between the PMI and the overall economy indicates that the average PMI for January through November (57.4 percent) corresponds to a 4.5 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for November (58.2 percent) is annualized, it corresponds to a 4.7 percent increase in real GDP annually.

The last twelve months:

PMI November 2017 thrift savings plan

 

Yield spreads: The yield curve has made a parallel shift upward, with both short and long rates increasing. I get this information from the Cleveland Fed, who had this to say:

Using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.4 percentage rate over the next year, even with October’s estimate and a bit above September’s 1.3 percent. Although the time horizons do not match exactly, the forecast, like other forecasts, does show moderate growth.

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next October at 11.8 percent, just down from September’s 12.0 percent, which was a drop from the August probability of 12.5 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from May to June.

Money Supply M2 in the United States increased to 13747.30 USD Billion in October from 13692.40 USD Billion in September of 2017.

The growth rate is what is meaningful here, and you can see that growth has accelerated over the past two months – a good sign for an expanding economy:

Money supply and the Thrift Savings Plan December 2017

 

Conclusion

All of the above data leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

Recommended Reading

This month I have been reading a new book by famed investor Ray Dalio: Principles: Life and Work. The book talks equally about his investing philosophies (well worth studying as he runs the world’s largest and most successful hedge funds) and his management philosophies (which are interesting, but need to be taken with many grains of salt considering the turmoil his organization has gone through).

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I stumble across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

 

October 2017 TSP Allocation Update

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

10/09/2017

Happy Fiscal New Year!

As some of the newer subscribers may have noticed, I occasionally skip doing an update if I get so far into a month that the next month’s data is just days away. September was one of those months, with a combination of travel, the day job (which seems to include a lot of evenings and weekends), and my better half announcing that she is pregnant with our first child (so you can look forward to a thorough writeup on tax-advantaged Coverdale and 529 accounts sometime in the next year). With my buy-and-hold-except-at-major-turns-in-the economy strategy, nothing which pops up in any given month is likely to result in a change, and if there is a major event I will certainly put something out.

Apparently there was also a problem with the email for the August update and some of you might not have seen that one. That was a longer, mid-year update, and it would be worth going back to read that here: August 2017 TSP Allocation Update

This will be a pretty quick update. First up though, I want to again thank the folks who donated to support the site since my last update. Some of you have been ridiculously generous, and it has been genuinely heartwarming.

Bottom line up front: I will be sticking with an allocation of 100% TSP C Fund in both my existing balances and new contributions this month (and probably for the foreseeable future).

Thrift Savings Plan Fund Returns

The stock market continued to move up nicely in September:

  • TSP C Fund:  2.06%
  • TSP S Fund:  4.26%
  • TSP I Fund:  2.52%
  • TSP F Fund:  -0.48%
  • TSP G Fund:  0.17%

And the TSP Funds year-to-date (through 10/06/2017):

  • TSP C Fund:  15.67%
  • TSP S Fund:  14.31%
  • TSP I Fund:  20.24%
  • TSP F Fund:  3.21%
  • TSP G Fund:  1.77%

In the News

It has been an eventful 60 days since the last update. We’ve had hurricanes, Nazis, anthem protests, charter flight scandal(s), and apparently everyone in this White House uses personal email accounts. A few more members of the inner circle were shown the door, North Korea dredged up the word “dotard”, Russia bought a bunch of Facebook ads, and LSU lost to Troy.

What does all of that mean to investors? Nothing really. As we have discussed before, none of these things will have an impact on the stock market for more than a few days unless we see war on the Korean peninsula or an impeachment. Neither of those are at all likely, and the market has responded accordingly. The market hates instability, and in a normal administration several of the issues above would have stocks bouncing around. But the market seems to have recalibrated for the daily chaos of the Trump years, and the reaction has been muted.

September’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

September saw the first monthly loss in total jobs in seven years, with a drop of 33,000 jobs. The number dipped into the red only because of the combined hurricanes, although it is worth noting that the estimate coming in of 90,000 jobs created would have been much lower than we are used to.

Total nonfarm payroll employment decreased by 33,000 in July, and the unemployment rate was little changed at 4.2 percent. That lagged estimates of approximately 90,000 new jobs created. The change in total nonfarm payroll employment for May was also revised down from 189,000 to 138,000, and the change for August was revised up from 156,000 to 169,000. With these revisions, employment gains in July and August combined were 38,000 less than previously reported.

Taking a look at employment gains since January 2015, you can see the job gains gradually declining, which is to be expected at this stage in the business cycle to some degree:

 

Average hourly earnings for all employees on private nonfarm payrolls rose by 12 cents to $26.55. Over the past 12 months, average hourly earnings have increased by 74 cents, or 2.9 percent.

I obtain this data from the Bureau of Labor Statistics.

Purchasing Managers’ Index (PMI):

As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The September PMI reading of 60.8 is the strongest number I can remember:

Manufacturing expanded in September as the PMI registered 60.8 percent, an increase of 2 percentage points from the August reading of 58.8 percent. This indicates growth in manufacturing for the 13th consecutive month and is the highest reading since May 2004, when the index registered 61.4 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the September PMI indicates growth for the 100th consecutive month in the overall economy and the 13th straight month of growth in the manufacturing sector.

The past relationship between the PMI and the overall economy indicates that the average PMI for January through September (57.1 percent) corresponds to a 4.4 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for September (60.8 percent) is annualized, it corresponds to a 5.5 percent increase in real GDP annually.

The last twelve months:

Yield spreads: The yield curve has made a parallel shift upward, with both short and long rates increasing. I get this information from the Cleveland Fed, who had this to say:

Using past values of the spread and GDP growth, our calculations suggest that real GDP will grow at about a 1.3 percentage rate over the next year. […]

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next September at 12.0 percent, down from the August probability of 12.5 percent (an even one-eighth chance), itself a tiny drop down from July’s 12.9 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from May to June.

Money Supply M2 in the United States increased to 13647 USD Billion in August from 13602.20 USD Billion in July of 2017.

The growth rate is what is meaningful here, and you can see that growth has flattened out to some degree between July and August in the chart below (but not something to worry about across a short period):

 

Conclusion

All of the above data leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

Recommended Reading

My investment reading has been interrupted by a deep dive into What to Expect When You’re Expecting, so I will repeat the recommendation from the last update: The Best Investment Writing: Selected writing from leading investors and authors: 1. Meb Faber has put out an annual list of the best articles on investing for several years now, and he is publishing it in book form this year. It is a compilation of the best pieces from a huge collection of the big name money managers and stock market researchers. They have agreed to have their work published in this book because all proceeds are going to charity. Lots of great content broken up into ten minute chunks.

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I stumble across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

 

August 2017 TSP Allocation Analysis

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

08/06/2017

cyborgs don't take vacationsWelcome back! The political scene has cooled down a little bit in the last week or two as the White House and Congress have headed out of town for their August vacations, so this month I will get back to talking about the economy and stock market. Unless I go off on a tangent, this update should turn into something of a mid-year review.

First up though, I want to again thank the folks who donated to support the site since my last update. Some of you have been ridiculously generous, and it has been genuinely heartwarming.

Bottom line up front: I will be sticking with an allocation of 100% TSP C Fund in both my existing balances and new contributions this month (and probably for the foreseeable future).

Thrift Savings Plan Fund Returns

The stock market continued to trend up nicely in July:

  • TSP C Fund:  2.05%
  • TSP S Fund:  1.11%
  • TSP I Fund:  2.88%
  • TSP F Fund:  0.43%
  • TSP G Fund:  0.19%

And the TSP Funds year-to-date (through 08/04/2017):

  • TSP C Fund:  11.93%
  • TSP S Fund:  8.18%
  • TSP I Fund:  18.09%
  • TSP F Fund:  3.10%
  • TSP G Fund:  1.38%

The Mid-Year Report

Just a reminder that I am a long-term investor and employ a long-term strategy. Anything can happen in the stock market in the next couple of months, and I don’t have any ability to predict that. What I can do is look at economic data and explain what the market would do if it was completely rational. It is not, of course, it swings wildly from overvalued to undervalued relative to economic output, but it always comes back to where it is supposed to be on average over time.

The economists I follow believe the US will see about 2.5% growth in the US for 2017. Inflation will almost certainly remain low. Job gains appear likely to continue to be steady but unspectacular, and wage growth will be the most important factor to watch in the employment arena. I think the Fed will move very slowly, raising interest rates at most once more this year, although they might well decide to wait until next year. They will start allowing their massive bond holdings to expire at maturity and not reinvest the money, and they won’t want to risk a shock by raising rates at the same time.

That level of growth and employment is textbook mid-stage of the business cycle — a stage during which the TSP C Fund has historically performed the best.

Turning to the global economy (and the TSP I Fund), Europe is doing well, although not growing as quickly as the US. The estimate there is about 1.7% growth for 2017. And Japan is growing a little bit more quickly than expected, and should grow about 1% for the year. That is good news even though I am 100% in US stocks in my Thrift Savings Plan, because that global stability bodes well for preventing meltdowns overseas which can impact the the US market.

So where are the risks? We talked more than enough about Russian interference and the collusion investigation in last month’s update. There is a lot of talk about geopolitical risks, but absent a war on the Korean peninsula, I don’t see anything else on the horizon likely enough to warrant concern. So my biggest concern is still the same as it was in my Look Forward at TSP Investing in 2017 post:  China’s debt bubble. If that pops, all the gains we have seen so far this year will be gone in a few trading sessions (and likely a lot more).

So where to from here? I’m up 12% for the year and I would be delighted with that return if it ended tomorrow. The five remaining months of 2017 is “the short term”, so I hate to make any sort of prediction as to how the market will perform. But there is no reason the market can’t keep going up (and no good reason for the market to go down) during that period. The TSP C Fund is based on stock prices, stock prices are based on earnings, and earning should continue to grow under current economic conditions.

Politics and the Thrift Savings Plan

But what of the huge changes coming to healthcare and taxes and infrastructure? Aren’t those going to give a big boost to the stock market?

Just a reminder that anytime I mention politics in this blog it is not to favor one party or the other, but rather just to explain how the news (and fake news) from DC impacts my investments. Please don’t take anything I write as a personal attack or an attack on your team, it is most assuredly not intended that way.

political gridlock and the TSPThe market has continued higher despite the failure of the Republicans to take advantage of holding the presidency, Senate and House to push through the agenda they campaigned on. And at this point, that inability to make major policy changes is probably considered a good thing by many investors who crave stability above all else.

The healthcare, tax and infrastructure reforms which were supposed to be completed before the August recess appear to be all but dead at this point. When Congress returns, the priorities will be the debt limit, continuing resolutions to keep the government open into the new fiscal year, and eventually some sort of budget. Anything which doesn’t get done this fall, probably isn’t going to get done because when we usher in the New Year, we will also start counting down to the 2018 mid-term elections and it will be even harder to push through major policy changes.

July’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

In my last update I expressed some concern over a few months of lower than expected job numbers. Things seem to be back on the right track now (perhaps bolstered by the surge in hiring of prosecutors and defense attorneys in the DC area).

Total nonfarm payroll employment increased by 209,000 in July, and the unemployment rate was little changed at 4.3 percent. That beat estimates of approximately 185,000 new jobs created. The change in total nonfarm payroll employment for May was also revised down from 152,000 to 145,000, and the change for June was revised up from 222,000 to 231,000.

Average hourly earnings for all employees on private nonfarm payrolls rose by 9 cents to $26.36. Over the year, average hourly earnings have risen by 65 cents, or 2.5 percent.

If you are trying to sort out whether claims of a huge increase in jobs is true or not, the first six months of 2017 (184,000 jobs created per month) are slightly behind the results in the first six months of 2016 (187,000 jobs created per month), and both of those are right in the range we have been seeing for six years now. A decline in growth makes sense as the economy is at full employment, so changes are typically more apparent in wages than jobs created at this stage. Here’s what it looks like over time:

I obtain this data from the Bureau of Labor Statistics.

Purchasing Managers’ Index (PMI):

As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The July PMI reading of 56.3 is a strong number:

Manufacturing expanded in July as the PMI registered 56.3 percent, a decrease of 1.5 percentage points from the June reading of 57.8 percent. This indicates growth in manufacturing for the 11th consecutive month and is the fourth highest reading in the last 12 months. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the June PMI indicates growth for the 98th consecutive month in the overall economy and the 11th straight month of growth in the manufacturing sector

The past relationship between the PMI and the overall economy indicates that the average PMI for January through July (56.4 percent) corresponds to a 4.1 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for July (56.3 percent) is annualized, it corresponds to a 4.1 percent increase in real GDP annually.

The last twelve months:

 

Yield spreads: The yield curve has made a parallel shift upward, with both short and long rates increasing. I get this information from the Cleveland Fed, who had this to say:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next July at 12.9 percent, a barely noticeable increase from June’s 12.8 percent (just above a one-eighth chance) and up a bit from May’s 10.4 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from May to June.

Money Supply M2 in the United States increased to 13519.30 USD Billion in June from 13495.50 USD Billion in May of 2017.

The growth rate is what is meaningful here, and you can see that it is growth has flattened out to some degree in the chart below:

Conclusion

All of the above data leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

Recommended Reading

I downloaded The Best Investment Writing: Selected writing from leading investors and authors: 1 this week, and it is a very good read. Meb Faber has put out an annual list of the best articles on investing for several years now, and he is publishing it in book form this year. It is a compilation of the best pieces from a huge collection of the big name money managers and stock market researchers today. They have agreed to have their work published in this book because all proceeds are going to the charities of their choice. Lots of great content broken up into ten minute chunks.

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I stumble across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

 

June/July 2017 TSP Allocation Analysis

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

06/11/2017

This month I write about the potential impact of the ongoing turmoil in DC and some danger signs from the employment indicator. Once again, this starts treading into political grounds and I’ll remind everyone that I’m not sharing my views on politics or favoring one side over the other, but rather discussing what impact the current craziness may have on my investments.

First up though, I want to thank everyone who donated to support the site after my shameless panhandling in last month’s update. For a little while after the post went live, my PayPal notifications sounded like that scene from Breaking Bad when Walt Jr. created the webpage for people to donate for Walt’s medical bills. (That’s a pretty obscure reference, but totally worth it for those of you who got it.) In all seriousness, I was overwhelmed by the generosity of so many people and will put those contributions to good use.

Speaking of which, I have been trying to transition the site from HTTP to HTTPS which means that any data sent between your browser and the website is encrypted. Not a big deal for a site like this one, but a little step to make it a bit more secure. Unfortunately, that hasn’t gone smoothly so if you have any trouble accessing the site, please let me know so I have more error data to work with.

Bottom line up front: I will be sticking with an allocation of 100% TSP C Fund in both my existing balances and new contributions this month (and probably for the foreseeable future). But remember a few months ago when I said not to attach too much importance to a single poor jobs report and to see what things looked like over a few months? Now we have had three lousy jobs reports in a row. So I’m not as confident as I was and you should probably read that boring economic indicator stuff below which you usually skip.

Thrift Savings Plan Fund Returns

May was a very solid month for the C fund, although I once again wish I had been smart enough to have been in the I Fund this month:

  • TSP C Fund:  1.41%
  • TSP S Fund:  -0.77%
  • TSP I Fund:  3.76%
  • TSP F Fund:  0.81%
  • TSP G Fund:  0.19%

And the TSP Funds year-to-date through 06/09/2017:

  • TSP C Fund:  9.68%
  • TSP S Fund:  7.31%
  • TSP I Fund:  14.58%
  • TSP F Fund:  2.62%
  • TSP G Fund:  1.03%

Russia, Politics and the Thrift Savings Plan

Comey FlynnI will caveat this with reminding you that I didn’t think the UK would vote for Brexit and didn’t think Trump would be elected president, so I have been bad at predicting major political events lately. That said, I don’t think Trump is going to be impeached (GOP controlled House and Senate, public acceptance of behavior which previously would have been disqualifying, lack of a smoking gun, etc.).

But I do think the investigation into Russian interference with the 2016 election and the extent to which members of the campaign either leapt or were pulled into that will last for at least as long as Trump’s presidency. Mueller would not be hiring the prosecution dream team he is if he had been briefed on the evidence and was just making sure the I’s were dotted and the T’s were crossed on a report detailing Russian interference but no collusion on the part of any Americans. People are likely going to prison, but it is probably going to take years for that to happen.

A much lesser issue, but the one which is actually appropriate to discuss on this blog, is what impact that is likely to have on the stock market.

Let’s start with the worst case scenario (or best depending on your politics). If we go all the way back to Watergate, a quick look at the charts would certainly make you believe that the scandal caused the stock market to tank. The break-in took place in June 1972, the market peaked at the beginning of 1973, and then fell about 50% until Nixon’s resignation in August 1974. But that doesn’t tell the whole story. The scandal didn’t begin to envelope Nixon and the White House staff until July 1973, by which point the US economy was already plunging into a recession which was exacerbated by an OPEC oil embargo later in the year which tripled oil prices. To be sure, the Watergate scandal did not help investor sentiment or market stability, but it was not the primary driver of the bear market.

The Clinton impeachment may be even more instructive because it took place during a more modern stock market. The market fell sharply in the months leading up to the release of the Starr report (down 20% from July 17 to September 9, 1998), but the primary drivers of that decline was the collapse of a hedge fund (Long-Term Capital Management) and a Russian economic crisis. And once things came to a head, between the start of impeachment proceedings on October 8, 1998 through the conclusion on February 12, 1999, the market saw a 28% gain.

Which brings us back once again to the conclusion that politics may have some day-to-day impacts on the market, but that medium and long-term results are driven by the economy.

The other Politics

Between the multiple investigations into Russian interference in the election and the battle over health insurance reform, there isn’t going to be much space left this year for major legislation which would potentially benefit the stock market. I don’t think we will see significant tax reform this year (or next), although there will certainly be some tweaks and claims of victory. Increased federal infrastructure spending similarly doesn’t look like it will materialize – in fact at this point it looks like infrastructure spending will decrease over the next few years.

What does that mean for our Thrift Savings Plan investments? I think to some degree the cut to corporate tax rates is already priced into the market, so if it becomes clear that isn’t going to happen we could see a small (5%) correction. But otherwise, as long as the economy keeps growing I don’t think the politicians are going to have much impact for the rest of 2017.

One Last Thing While We are Talking About the Politicians

You probably saw the flurry of articles and tweets about the potential for drastic cuts to Federal employee retirement programs after the White House released its budget proposal. The actual proposal was short on details, but the briefings around it made it clear that they envision implementing a wishlist of Heritage Foundation proposals to gut the system. A good run-down on the key points is in this Washington Post article.

The worst case scenario would include a $5000 cut in actual take-home pay for the average Fed, as well as effectively halving the value of a Fed’s pension by the end of their retirement due to elimination of cost of living adjustments.

The administration’s proposal doesn’t mean all, most or even many of these cuts will actually make it through Congress. And doesn’t reflect the political reality that it is much easier to impose cuts on voiceless future employees rather than current ones. But it is something to keep a close eye on as the budget process gets underway on Capitol Hill because this Congress and administration are more likely to take these actions than any during my Federal service. And once the cuts are made, they almost certainly aren’t coming back no matter who takes office during the next election cycle.

May’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

Total nonfarm payroll employment increased by 138,000 in May, well under estimates of 185,000 jobs.

To make things worse, jobs numbers for March were revised down from 79,000 to 50,000, and for April were revised down from 211,000 to 174,000. With these revisions, employment gains in March and April combined were 66,000 less than previously reported.

So over the past 3 months, job gains have averaged only 121,000 per month, which is very weak. For comparison, roughly 200,000 jobs were created monthly under Obama during the recovery after the recession ended in 2010. For more comparisons, 166,000/month during Reagan’s entire presidency (with a smaller economy and workforce), about 54,000/month under Bush 1, 242,000/month under Clinton, and 58,000/month under Bush 2 when 2002 is excluded to account for the recession he inherited.

And hourly wages increased just 2.5 percent from May 2016, a decrease from the trend and way below average as you can see in the chart below:

I obtain this data from the Bureau of Labor Statistics.

I won’t panic based on these numbers, but I will be watching closely to see where we go from here.

Purchasing Managers’ Index (PMI):

As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The May PMI reading of 54.9 is a strong number:

Manufacturing expanded in May as the PMI registered 54.9 percent, an increase of 0.1 percentage point from the April reading of 54.8 percent, indicating growth in manufacturing for the ninth consecutive month. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the May PMI indicates growth for the 96th consecutive month in the overall economy and the ninth straight month of growth in the manufacturing sector.

The past relationship between the PMI and the overall economy indicates that the average PMI for January through May (56.1 percent) corresponds to a 4.0 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for May (54.9 percent) is annualized, it corresponds to a 3.7 percent increase in real GDP annually.

The last twelve months:

Yield spreads: The yield curve moved up and became slightly flatter in May. I get this information from the Cleveland Fed, who had this to say:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next May at 10.4 percent, up from April’s 9.8 percent and March’s 7.4 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from February to March.

Money Supply M2 in the United States increased to 13435.60 USD Billion in April from 13390.60 USD Billion in March of 2017.

The growth rate is what is meaningful here, and you can see that it is moving at a good clip:

Conclusion

All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

Things I Like

This is probably a bit of a one-off, but after my work phone was recently upgraded to a Samsung S7 I realized that it was capable of wireless charging and that sounded wonderful since I was fiddling around with cords about a dozen times a day and I just like things like that. Apparently only the SESers in my organization rated free cordless chargers, so I had to find one on my own. I read a lot of reviews and finally settled on a Pleson Ultra Slim Fast Wireless Charger, because it was a top seller on Amazon and for $15, no big deal if it didn’t work.It did work and for some reason it gives me more pleasure than anything else I have bought this year. Setup was as simple as plugging my existing charging cable into the pad. If you have a cell phone capable of wireless charging, you really need one of these.

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I stumble across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

 

April 2017 TSP Allocation and Business Cycle Analysis

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

04/25/2017

This will be a fairly short update as April is almost over and I need to get it out, so please excuse any typos and the lack of charts this month. I will talk about the terrible, no good, horrible March jobs report and why it wasn’t a big deal, and a bit on the politics and geopolitics effecting the market day to day.

I’m also going to talk just a bit about why I think the TSP Life Cycle Funds and other strategies which move increasing proportions of investors’ balances to bonds as they approach retirement are overly conservative for investors who have a defined annuity in addition to a Thrift Savings Plan or 401k.

The surge in the market over the past couple of days was largely a result of the French primary election on Sunday. The results of that election pretty much guaranteed that France will not move towards leaving the European Union, which the stock markets liked from a stability standpoint. So that caused money to go sloshing back into riskier assets, and out of “safe” things like treasury bills.

Bottom line up front: I will be sticking with an allocation of 100% TSP C Fund in both my existing balances and new contributions this month (and for the foreseeable future).

Thrift Savings Plan Fund Returns

Everybody likes seeing the numbers, so here you go. March was more or less flat, with the exception of the I Fund which continued its nice move:

  • TSP C Fund:  0.12%
  • TSP S Fund:  -0.08%
  • TSP I Fund:  2.85%
  • TSP F Fund:  -0.01%
  • TSP G Fund:  0.20%

And the TSP Funds year-to-date in 2017 (through 04/25):

  • TSP C Fund:  7.35%
  • TSP S Fund:  6.45%
  • TSP I Fund:  10.19%
  • TSP F Fund:  1.46%
  • TSP G Fund:  0.75%

Why Shifting to the G Fund as you get Closer to Retirement is Overly Conservative

This is a subject I get a lot of questions on, so I thought it was worth a little space this month. At some point I will come back to this topic and give some numbers for various scenarios, but this will just be a quick summary for now.

Most Americans no longer have a defined benefit plan (a pension). As a result, to replace the income they earned while working they rely on Social Security and disbursements from their defined contributions plan (typically a 401k). Because the disbursements from their 401k is such a key part of their retirement income stream, for many it makes sense to protect a sizeable portion of their investments to avoid having a badly timed crash substantially reduce their income for the length of their retirement.

What they are doing is trading returns for stability – they will certainly receive a lower rate of return over the long term, but by betting both that the stock market will go up (by investing in stocks) and that it will go down (by investing in bonds) at the same time, their gains and losses effectively cancel each other out. That’s great from a stability standpoint, but the result is their returns essentially consist only of dividend yield (from the stock funds) and interest earned (from the bond funds).

Federal Employees and military service members have a very different system. In addition to Social Security and TSP disbursements, we also receive an annuity based on number of years worked and our salary prior to retirement.

That annuity is just like a big, safe, not-going-anywhere bond fund. That is money we are definitely going to get, but it is not going to grow – at best it is going to keep up with inflation. Just like the G Fund.

If we double up by also allocating a large percentage of our Thrift Savings Plan balance to the TSP G Fund, we have “protected” the part of our savings which doesn’t really need protecting and which is supposed to be growing for us.

Geopolitics and the Thrift Savings Plan

North Korea, Syria, Russia, ISIS – you will see headlines from various sources attributing the daily ups and downs of the stock market to worries over missile launches or reactions to terrorist attacks overseas. That’s pretty much all nonsense, even on a short-term basis – the media just needs to fill space so they can sell advertising, so the daily explanation for why things moved ever so slightly in one direction or the other gets spewed out. Nothing in the overseas news at this point should have an impact on the long-term direction of the stock market.

Politics and the Thrift Savings Plan

Notwithstanding all the noise coming out of DC these days, the only thing which might have a significant impact on the stock market moving forward would be tax reform. That is an easy issue to talk about in campaign speeches, but may be even more difficult to enact than a replacement for the Affordable Care Act. If recent efforts on healthcare are any indication of how likely we are to see legislation in other areas, market moving corporate tax cuts and overseas profit repatriation might be a long time coming.

All the other news reports (shutdown, executive orders, health care redo, etc.) can only move the market in the very short term – a few days at the most (and probably not even that).

March’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

Total non-farm payroll employment increased by just 98,000 in March, which was well below expectations and the worst number we have seen in a while. But at the same time, the unemployment rate dropped from 4.7 percent to 4.5 percent. And hourly wages increased 2.7 percent from March 2016. (I obtain this data from the Bureau of Labor Statistics.) So what do we do with these apparently contradictory numbers?

First, it is helpful to explain that the numbers come from two different sources. The jobs number is the result of a survey of businesses and government agencies, while the unemployment rate is generated by a survey of American households (literally asking individual people whether or not they had a job that month). The discrepancy between the two surveys can often be attributed to how the data deals with factors such as weather, part-time and off-book employment, and people entering and leaving the workforce.

So all that said, I take two things away from the employment numbers this month: (1) I’m reminded not to put too much confidence into monthly data, and remember that these hiccups smooth out over longer periods of time, and (2) for the last few months I have been repeating that: “We are in the full employment range, so at this point we also glance at some other numbers like wage growth and number of people entering/reentering the workforce to gauge whether things are still moving in the right direction.” This month’s strong wage growth number is exactly what I have been talking about there and tells me that the economy is continuing to strengthen.

Purchasing Managers’ Index (PMI):

As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The February PMI reading of 57.2 is a very strong number:

Manufacturing expanded in March as the PMI registered 57.2 percent, a decrease of 0.5 percentage point from the February reading of 57.7 percent, indicating growth in manufacturing for the seventh consecutive month. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the March PMI indicates growth for the 94th consecutive month in the overall economy and the seventh straight month of growth in the manufacturing sector. The past relationship between the PMI and the overall economy indicates that the average PMI for January through March (57 percent) corresponds to a 4.3 percent increase in real gross domestic product (GDP) on an annualized basis.

Yield spreads: The yield curve moved up and became slightly flatter in March. I get this information from the Cleveland Fed, who had this to say:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next March at 7.43 percent, up a bit from February’s estimate of 5.63 percent and January’s estimate of 5.46 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from February to March. The growth rate is what is meaningful here, and if I wasn’t rushing and put in the chart you would be able to see the growth rate gapping up nicely:

Money Supply M2 in the United States increased to 13390.60 USD Billion in March from 13313.10 USD Billion in February of 2017.

Conclusion

All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

A New Section in Which I Try to Make you Feel Guilty

This website is always going to be free for you, and my goal has been to have it be break even for me (it’s easier for me to get permission to do this from my agency if I am just bringing in enough money to cover expenses). But lately expenses from the upgraded hosting (so the site doesn’t crash from the flood of traffic when I send out an update) and the service for the giant email list (which costs over $100/month) have been outpacing income from the ads on the site and the donations I’ve received. I discovered while I was doing my taxes that I actually lost a little money doing this last year.

The options are to put more ads on the site (maybe some of those fancy pop-up interstitials), to move the mail list to a cheap dodgy provider, or if 1/10th of the people reading this kicked in a dollar it would pay all the expenses of the website for a year. So if you think that sounds like fun, you can donate to support the site here.

(While we are on the subject, I owe a number of folks who have donated over the past few months an email thanking them for doing so, and I’m sorry to have been slow to do that. I am always humbled and amazed by your generosity when those donations come in, and it makes me feel really good about the little community we have created here.)

Recommended Reading for TSP Investors

I was too busy to read anything new this month. A number of my favorite past recommendations are compiled on this page if you are looking for something else to read:

http://www.tspallocation.com/tspresources/#reading

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I have stumbled across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

 

March 2017 TSP Allocation and Business Cycle Analysis

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

03/16/2017

Welcome back for another month of “How high can we go?”

This month I will talk about the impending correction (I learned teaser lines like that from the internet), my views on the market’s overall valuation and moves by the Federal Reserve, and of course I will run through the economic indicators.

Thanks for all the notes from folks eagerly awaiting a fresh update and asking if I was okay. It was good to feel missed. The “Look Forward at TSP Investing in 2017” covered the January update, and February was so short it just didn’t seem worth the trouble.

Thrift Savings Plan Fund Returns

The market flattened out over the last month, but has still had a pretty fantastic run since Election Day. The TSP Funds for 2017 year to date (through 03/15):

  • TSP C Fund:  7.03%
  • TSP S Fund:  4.61%
  • TSP I Fund:  6.44%
  • TSP F Fund: 0.19%
  • TSP G Fund:  0.48%

And here is the TSP C Fund chart since the election:

TSP C Fund Since Election

The Impending Correction

In my New Year’s predictions each January I write this:

As at the beginning of every year, I will confidently predict we will see four or five 5% corrections, and probably a 10% correction at some point (because that happens pretty much every year). With history as a guide, I am convinced the timing of those corrections isn’t predictable, and that the market will recover and move higher in each case within a matter of weeks.

It’s going to come, it’s just a matter of when. You have to go way back into 2016 to find a 5% correction, so from a statistical standpoint we are way overdue.

The hard part is not falling into the trap of believing that because we are almost a quarter of the way through 2017 and it hasn’t happened yet, it must be imminent. The truth is, it could happen tomorrow or it could happen in another 4 months after the market has run up another 10%.

I am a dispassionate, relatively clever (I must be, I have a blog) investor. But I fall into that trap of not wanting to buy at market highs as much as anyone else. On January 1st I made a non-deductible contribution to a traditional IRA, then promptly converted it into a Roth IRA (the “backdoor Roth” maneuver). So I had $5500 sitting there in cash. My plan was to buy a low-cost, vanilla S&P 500 ETF with that money. But the market was so high, and it had been so long since we had seen a correction – surely the market would hiccup and I would have an opportunity to buy in at a lower price if I just waited a week or so, right?

Two months later, the S&P 500 is up 7% and I still have $5500 sitting in cash. So that’s about $385 I missed out on – not a lot of money, but still dumb. What I should have done if I really wanted to make sure I didn’t buy just before a downturn was average in – I should have bought in at $1000/week until it was all invested (or whatever amount I was comfortable with). Part of the problem is that I didn’t wake up every morning and think about whether or not I was doing the right thing. Instead I occasionally remembered that the money was sitting there, kicked myself, and went back to reading Twitter. Which goes to show that I needed a plan and I needed to stick to it. “Waiting for the market” wasn’t a plan.

Is the Market in a Bubble?

The financial media has turned into reality television, and reality TV needs conflict to keep viewers watching. The theme this month seems to be trotting talking heads out who will say the market is overvalued to the point of being in a bubble and we will see a huge collapse when that bubble bursts. That’s an easy one, because when it doesn’t happen they can double down and talk about how the market has gotten even bubblier and the impending crash is going to be that much worse.

I think the market is expensive right now, but certainly not in bubble territory. When we are in a bubble, stock valuations aren’t based on anything except momentum. Right now when you look at where the Price/Earnings ratio is of the S&P 500 (the TSP C Fund) calculated with estimated earnings per share for 2017, you get a number just a shade over 18. That’s above average (average is 15.64), but not even close to bubble territory.

What did the Fed’s move this week mean?

The Federal Reserve was in the news a lot this week as they met and decided to increase interest rates. The Fed also indicated that they intend to increase rates again several more times this year. What does that really mean to us?

The big takeaway is that this high-powered group of economists believes the US economy is doing so well that they have to tap the brakes and keep it from overheating. When rates go up, borrowing gets more expensive for both businesses and consumers who respond by spending less, so this action is intended to slow down and smooth out growth.

And of course, a strong economy is a good sign for stock market investors, because the only thing we are really worried about at the end of the day is the possibility of a recession. If the Fed thought there was any prospect of that happening, they would not be raising rates.

February’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers:

Total nonfarm payroll employment increased by 235,000 in February, and the unemployment rate was little changed at 4.7 percent. I obtain this data from the Bureau of Labor Statistics.

We are in the full employment range, so at this point we also glance at some other numbers like wage growth and number of people entering/reentering the workforce to gauge whether things are still moving in the right direction. But for the most part, this indicator is pretty well played out for this business cycle until we see a lot fewer jobs being created several months in a row.

February Unemployment TSP allocation guidePurchasing Managers’ Index (PMI): as usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The February PMI reading of 57.7 is a very strong number:

Manufacturing expanded in February as the PMI registered 57.7 percent, an increase of 1.7 percentage points from the January reading of 56 percent, indicating growth in manufacturing for the sixth consecutive month, and is the highest reading since August 2014, when the PMI registered 57.9 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the February PMI indicates growth for the 93rd consecutive month in the overall economy and the sixth straight month of growth in the manufacturing sector. The past relationship between the PMI and the overall economy indicates that the average PMI for January through February (56.9 percent) corresponds to a 4.3 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for February (57.7 percent) is annualized, it corresponds to a 4.5 percent increase in real GDP annually.

And here’s a snapshot of the last 12 months:

February PMI Thrift Savings PlanYield spreads: The yield curve moved down and became slightly flatter in February. I get this information from the Cleveland Fed, who had this to say:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate that the expected chance of the economy being in a recession next February is 5.63 percent, up from January’s estimate of 5.46 percent and December’s estimate of 4.07 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

The probability of recession calculated from the yield curve:recession probability

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from December to January. The growth rate is what is meaningful here, and you can see that rate has flattened out since November in the chart below – not a big concern, but something we keep an eye on:

Money Supply M2 in the United States increased to 13270.10 USD Billion in January from 13246.90 USD Billion in December of 2016.

Conclusion

All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.

Recommended Reading for TSP Investors

This month’s recommended book is Stocks for the Long Run by Jeremy Siegel. This is a fantastic book by one of the leading teachers in the field and is well worth the investment of time and the price of a couple of cappuccinos.

And my favorite past recommendations are all compiled on this page if you are looking for something else to read:

http://www.tspallocation.com/tspresources/#reading

 

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I have stumbled across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

TSP Investing in 2017

 

TSP investing 2017

How I see the economic news shaping the stock markets over the next twelve months generally doesn’t change between Thanksgiving and the start of the New Year. So most years my “look forward” post has pretty much written itself in my head by mid-December and I just need to get around to putting it on paper.

This year is different. This year I wanted to wait to see what happened in the aftermath of the Inauguration. To be sure, a week and a half isn’t nearly long enough to figure out how things are likely to sort themselves out and what direction we are really headed on some pretty consequential issues, but I can’t very well wait until June to put out my New Year’s forecast.

As I sit down to write my forecast, I’m reminded of a quote from Warren Buffett: “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” I always hesitate to stray from the numbers, and having this quote in the back of my mind makes me even more leery about discussing the unknowns instead of just pointing at historical data the way I usually do. But this year I think the unknowns are going to cause more volatility than normal, and in some cases even be significant enough to overcome the numbers.

The stock market (and our Thrift Savings Plan) is usually moved by earnings, economic data and monetary policy. In the first year of the Trump administration, I suspect that short term moves are going to be driven by political events to a degree which we haven’t seen in my investing career. That is going to cause a lot of anxiety for people who breathlessly follow every move of the market.

The good news is that no matter what happens on TV (or Twitter), stock prices are still going to come down to earnings over the long term. But a lot can happen between now and the long term. I generally believe that politicians get much too much credit and often too much blame for the economy’s performance, but there certainly are some political decisions which could change the trajectory of earnings and the long term direction of the stock market.

If We Were Only Talking About the Economy

The stock market goes up two years out of three. Pull out the years when the US is in recession and it gets even better than that. All indications are that the US will avoid recession in 2017.

I believe the overall stock market will in all likelihood end the year higher than where it started. From a price to earnings ratio perspective, right now the stock market doesn’t have a lot of room to grow (meaning the market’s current P/E is well above average), so don’t think the market is likely to grow double figures again this year as it did last year. A significant corporate tax cut (to effective rates, not just to listed rates) and a deal to repatriate overseas profits could add a point or two to returns if implemented. If I was guessing (and it really is a guess), I tend to think we will see mid-to-high single digit returns.

But even if I have guessed exactly right and we wind up with a 7.5% or 8.5% gain at the end of December, it isn’t going to be a gentle curve from where we are now until then. In 85% of the years since World War II in which the stock market has been up for the entire year, the stock market was down year-to-date at some point during that year. That’s 85% of the up years (and 100% of the down years for those of you who haven’t had your caffeine yet), so there are really good odds that we will lose all the gains we have had since January 1 and then some.

And in 75% of those up years, that dip below break-even came during the first quarter.  We are a month into the first quarter, up 2.6% year-to-date, valuations are high, sentiment is starting to waver – I’d say there is an excellent chance we will see a 5% to 10% correction at some point in the next two months.

So why aren’t I hiding out in the G Fund and waiting until that dip to move back to the C Fund? Because there is also a pretty good chance that we will see the market go up 10% in the next two months before it has a 5% correction. And there is absolutely no way of knowing which scenario will play out.

As at the beginning of every year, I will confidently predict we will see four or five 5% corrections, and probably a 10% correction at some point (because that happens pretty much every year). With history as a guide, I am convinced the timing of those corrections isn’t predictable, and that the market will recover and move higher in each case within a matter of weeks.

Risks to the TSP Stock Funds in 2017

The first week and a half of the Trump presidency coupled with a GOP Congress no longer checked by the veto generated a lot of headlines. I don’t think that is likely to slow down anytime soon. So far we have mainly seen domestic issues in the foreground, but China, Russia, North Korea, other adversaries and even our allies are going to test the new administration. I suspect that both sides will miscalculate in some instances, causing uncertainty in the stock market. And everyone knows how much the stock market hates uncertainty.

So which of the headlines is it safe to shrug and ignore, and which could cause real damage to the economy? It is hard to even guess at all the possible issues which are going to cause jitters, but as in most years I think my only option will be to ignore and ride out most of the volatility we see. It is important to remember that the economy and stock market are both very resilient. The market will jump around a great deal, but typically recovers from “disasters” fairly quickly.

There is a lot of talk about trade wars in the news these days. There has been a lot of posturing so far, but even if most of the threats play out as badly as possible (significant tit-for-tat with Mexico, withdrawal from NAFTA, etc.), those aren’t by themselves going to cause the recovery to fail. The trade war which could push the global economy into recession would be between the US and China.

China is in a fragile position with its massive debt bubble. A significant economic conflict with the US could well cause a financial crisis in China and start a chain reaction which would pull down markets all over the world. The US would do better than most in that scenario (we export relatively little to China compared to Europe, for example), but a major Chinese correction would certainly be reflected by a double digit pull-back in US markets.

The other thing we are seeing in the news every day are protests. I don’t think that it going to let up anytime soon. But I also don’t think that is likely to impact economic growth. At the height of the protests agains the Vietnam War in 1967 and 1968, we saw 23.8% and 10.81% returns. Charts of negative investor sentiment match up nicely with unpopular administrations, but investor sentiment is actually a contrarian predictor of market performance – the more negative investor sentiment is, the better markets typically do.

Political news can certainly cause volatility, but it is generally short lived and I’m not sure I can find an example of lasting damage to the economy in the last 100 years. Scandals, indictments and resignations are usually good for a few days downturn at most. Even impeachments aren’t necessarily a big deal – the market was in considerable turmoil as Bill Clinton’s Monica Lewinsky scandal unfolded, but that was largely due to the Russian debt default – markets actually gained 9% during the impeachment hearings themselves. And as huge an event as Watergate was, the bear market of 1973 and 1974 was probably much more a result of inflation taking off (4% to 12% in the space of a year) and the Arab oil embargo which started in 1973.

Saturday marches and airport sit-ins aren’t going to break the economy, but widespread, sustained middle-class civil disorder would certainly stifle earnings and cause massive uncertainty on Wall Street. Anything is possible, but that scenario is so unlikely in my opinion that it isn’t something I would factor in while making investing decisions at this stage.

So what else are people worrying about when it comes to investing right now? Not to be glib about absolutely horrific events which devastate lives, but a widely publicized terror attack usually causes only a one or two day blip in the market, and a war of our choosing is usually a net positive for the stock market (it turns out government spending is good for the economy after all).

So which TSP fund?

Typically at this stage in the business cycle, large cap stocks (the TSP C Fund) will outperform small and medium cap stocks (the TSP S Fund). And for that reason, I usually wouldn’t consider moving any part of my allocation to the S Fund. So what factors might weigh into the decision to deviate from the business cycle strategy?

The main argument we have been hearing in the financial media is that if the GOP enacts significant corporate tax cuts, small and medium sized companies will disproportionately benefit. That is because they are actually paying something close to the listed tax rate, whereas the effective rate of the huge multinationals which make up the TSP C Fund is much lower because they have the opportunity to shelter many of their profits overseas.

Additional arguments are that (1) because these smaller companies do less business overseas, they will be impacted to a lesser degree by any trade wars which might break out, and (2) because their production and sales are already predominantely here in the US, any “buy American” rules in new government infrastructure and defense spending will push their earnings up more than large caps, which are producing their products overseas.

The argument against moving money into the TSP S Fund is that small cap stocks have had quite a run over the last year and are very richly valued (currently at 22x, which is way over their median P/E). That doesn’t mean they can’t go higher, but the Russell 2000 has only traded above 19x for a total of six months in the past 38 years. Read that last sentence again. That’s about 1.3% of the time.

Those harsh realities make it a fairly easy choice for me – I think the S Fund is just too rich right now and the possibility for earnings to grow significantly enough to bring that ratio back into line exists, but a lot of things would have to go right for that to happen. So I am keeping my TSP allocation at 100% C Fund. (The C Fund is also well above its historical average, mind you, but not to the degree the S Fund is.)

This is where those big disclaimers come in about how you should set your allocation based on your own circumstances, because they are almost certainly different than mine. I have several hundred thousand dollars in small cap ETFs in my other investment accounts. So I did well with those last year as small caps ran up, and I have that percentage of my overall investment portfolio in small caps if they continue to outperform. I don’t still own these small caps because I think they will outperform large caps – I don’t. I still own them because they are in regular (non-tax advantaged) accounts and if I sell them I am going to pay a lot of taxes on my profits. I would prefer to wait and see what my tax rates are going to look like under the new administration before I start writing checks to the US Treasury.

If I didn’t have fairly substantial small cap holdings outside the TSP, I would probably hedge a little bit and have some small allocation to the S Fund – 10% or 15% perhaps.

What about the TSP I Fund? No. Just no. For all the reasons I discussed in last September’s update.

Please don’t ever forget that these allocations are based on my circumstances and the strategy which I have chosen to employ. Your circumstances may be very different and my strategy may not work, so I encourage everyone to read widely and consider a range of different viewpoints before making investing decisions for themselves.

“Nobody knows anything…”

Over the holidays I was at a dinner party with a couple of venture capitalists and hedge fund types, which led to a fantastic conversation with some really clever people who have made a lot of money investing. We debated all the things I wrote about above – the politics, valuations, economic data, and allocations – but really couldn’t reach a consensus on anything. Is Tesla horribly overvalued, or will we look back and kick ourselves for not buying it at this level? Will all the Goldman Sachs alum in the new administration be able to keep the economy moving in the right direction? Even if Congress, the President and the Federal Reserve all do just the right things, could something else push us into a recession?

As we finished a bottle of wine and went quiet for a moment, one of them looked around at the rest of us and said, “Nobody knows anything about what’s going to happen this year.” And it’s true. All we can do is look at the history of stock market performance and extrapolate from that, but even then a year is too short to forecast with any sort of confidence. Over the long term (much longer than a year), the market is almost certainly going to go up. And there are some patterns in the past for which good arguments exist to suggest they may be repeated in the future. But don’t let anyone fool you into thinking they can do much better than that.

Coming Up

In my next post I will resume discussing the economic indicators which I think are important, and hopefully find some time to talk about how I see investing outside the TSP in the coming year.

In the meantime, if you find this website useful or interesting, you can help me out by linking to this site from your own webpage or blog; liking it on Facebook (updates will show up in your news feed if you do); sharing on Twitter and in other investing forums; or actively participating on our Message Board. Please do me the favor of sharing it with your friends and colleagues using the email and social sharing buttons below right now.

And if you are still looking for something to read, there’s always this gem which I post a link to at this time every year: Debunking the January Myth

December 2016 Thrift Savings Plan Allocation and Business Cycle Analysis

THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.

12/11/2016

TSP taking off like a rocketThe stock market has soared since the election. In this month’s update I will:

  1. discuss the recent rally
  2. talk about the S Fund’s strong performance
  3. throw some cold water on the idea that the market is headed to the moon and beyond
  4. finally dump the TSP I Fund and go to 100% C Fund
  5. run through the most recent economic data

Thrift Savings Plan Fund Returns

A lot of TSP investors agonized over whether they should move to the “safety” of the G Fund over the election. Those who did wound up watching the market’s tail lights as it jumped up in November:

  • TSP C Fund:  3.71%
  • TSP S Fund:  7.95%
  • TSP I Fund:  1.99%
  • TSP F Fund: -2.35%
  • TSP G Fund:  0.16%

And 2016 overall is shaping up to be a very strong year (through 12/9/2016):

  • TSP C Fund:  12.92%
  • TSP S Fund:  18.57%
  • TSP I Fund:  1.65%
  • TSP F Fund:  2.37%
  • TSP G Fund:  1.67%

 The Rally

Not a bad little run in the market over the past month:Thrift Savings Plan Rally

The media, which really likes simple explanations for complex events, has dubbed this the “Trump Rally”. I’m inclined to think that the anticipated changes to corporate tax rates, the regulatory environment and infrastructure spending are largely offset by uncertainty about what we are really going to see and when those changes might actually materialize. I see this rally as being fueled by the removal of election uncertainty, the typical bounce we see in the market this time of year, and the steady stream of very positive economic news. Either way though, I will take it.

Two other common areas of discussion are the strong performance of the TSP S Fund since the election, and how far this rally can run.

The TSP S Fund

The TSP S Fund has had a great year, up 18.57% through today, and up 9.43% just since the election. A fair number of readers have watched it sprinting ahead of the TSP C Fund and rightly wondered whether we could have predicted that, and having failed to do so, whether we should be moving that way now.

I just want to reiterate that the Business Cycle Strategy doesn’t predict what is going to happen in a given month or quarter or year. What it does is show what has happened on average in the past during similar economic environments. Of course there are a lot of other things pulling the stock market in one direction or another, so while I think it gives me the best opportunity to do well during a typical year, I accept that the indicated fund isn’t going to be the best performer in many years. And that’s okay with me because I am invested for the long term, and over the long term I believe this strategy will average out to the highest returns.

So could we have seen this coming? Sort of. From a valuation standpoint (looking at price to earnings (P/E) ratios), the TSP S Fund was cheap compared to the TSP C Fund. At some point, all of these ratios are going to come back towards their average (this is what they call reversion to the mean).  So as an example, if Fund X’s P/E ratio is 20 but it’s historical average is 15, it is a pretty safe bet that at some point Fund X’s price will either fall back towards that average or stay flat until the earnings of companies in Fund X rise enough to bring that ratio back into line.

But of course historical averages span all of the phases of the business cycle, so you wouldn’t sell a stock fund during the recovery phase of a cycle just because it had a higher than average P/E ratio – it is supposed to be higher than average during that period in anticipation of higher earnings, just as it is lower during recession. And that’s the same reason the S Fund’s valuation relative to the C Fund is interesting, but not typically something which will cause me to adjust my strategy late in the business cycle. I expect the C Fund to outperform the S Fund during this phase, so I expect the C Fund’s P/E ratio to be further from its average than that of the S Fund.

The TSP C Fund was fully valued as we went into the election. That part of the stock market is seen as safer, so that’s where the money had been going. After the uncertainty was removed and the markets rallied when the election was over, the “risk-on” trade kicked in and cash flooded towards that “undervalued” part of the market. There are some analysts making the case that these smaller companies do more business domestically so they might do better under Trump than the huge multinationals which dominate the TSP C Fund. I think a lot of that is trying to find a complicated explanation for something which is really pretty simple. And remember, we aren’t talking about small business here: the average market value in the TSP S Fund is over $1.3 billion.

So should I move some of my allocation to the TSP S Fund? One of the absolute axioms of investing is “Don’t chase performance.” Study after study has shown that when investors try to invest in sectors of the market after a period of high performance, they almost inevitably do worse than they would have if they had stuck with their current investment strategy. (The exception is when radical innovation creates new markets and massive long-term growth in an area (the internet, mobile telephones, etc.)). The S Fund has caught up and passed the C Fund from a valuation perspective – the P/E of the S Fund is 20.3 compared to the C Fund’s 19.4. The S Fund may well still outperform the C Fund for a while, but I don’t see an argument for that to continue long term.

How high can we go?

A rising market breeds optimists, and there are plenty of them out there suggesting that infrastructure spending and lower corporate taxes will usher in a period of sustained growth. Both of those changes would be positive things for the stock market, but there is a limit to what we can expect. The chart below demonstrates pretty dramatically what typically happens when the US economy is at full employment.

unemployment relationship to stock market returns

Chief among the reasons for the drop in returns is that when the economy is at peak performance (and no, peak performance does not mean optimal performance), interest rates rise. When interest rates rise, investors looking for safe returns move to the bond market. It is hard for investors to convince themselves that bonds are a good idea when interest rates are lower than inflation. But as rates tick up, more and more capital will switch to bonds.

I am very confident the Fed will raise interest rates next week. That 1/4 point hike won’t have the effect I described above – it will take many more hikes to divert a lot of money from the stock market. But it will take a little bit, and another rate hike in the Spring will take a little bit more, and eventually that will put a cap on money flowing into the market.

Long term, I don’t see a catalyst for unusual growth which would “reset the business cycle” and fuel a new bull market. There is some talk about a manufacturing revival in the US among politicians, but note that nobody is talking about that in the financial world. In 1800, 98% of Americans lived on farms. In 1900, 30% of Americans lived on farms. In 2000, 2% of Americans lived on farms. I am old enough to remember the politicians pandering to the idea that the family farms were going to come back and things were going to be like they were in “the good old days.” That is exactly what we are going through with manufacturing right now, and the result is going to be the same. There will still be huge quantities of goods manufactured in the US in certain industries, but it will be a small fraction of what it was.

Don’t get me wrong, I’m not selling my stock holdings and looking for alternatives. But I think we are unlikely to see many years of double digit returns in this phase of the business cycle. I hope to be wrong as much as anyone, because I suspect I will be fully invested in the stock market for the entire year.

Shorter term, as always I will fearlessly predict a 5% correction at some point in the next 30-60 days, just because most of the time I will be right when I say that. In this instance, I think it is even more likely than usual after the recent run up. This isn’t something which we can predict accurately enough to do anything with from a trading standpoint, but knowing that it is inevitably going to happen keeps us from being stressed when it does.

The TSP I Fund

I assumed I would find an exit point from the TSP I fund every month since the Brexit vote, but it made a strong move up following that vote so I stuck with it short term. That run has clearly ended, and I never like to play timing games in my TSP anyhow, so I will change my allocation and contributions to 100% TSP C Fund tomorrow.

I wrote a long explanation of why I had invested in the I Fund and why things had changed back in September. Rather than rehash all of that content again, I will simply provide a link: http://www.tspallocation.com/current-thrift-savings-plan-allocation-business-cycle-analysis-september-2016/

If you need a refresher on the I Fund, take a quick look at this post in which I explain the TSP I Fund in some detail and talk about when I think it is a good investment: The Role of the TSP I Fund in TSP Allocation Strategy.

November’s Economic Numbers:

In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)

Employment numbers: Total nonfarm payroll employment increased by 178,000 in November, and the unemployment rate fell to 4.6 percentI obtain this data from the Bureau of Labor Statistics.

We are in the full employment range, so at this point we also glance at some other numbers like wage growth and number of people entering/reentering the workforce to gauge whether things are still moving in the right direction. But for the most part, this indicator is pretty well played out for this business cycle until we see several months of job losses in a row.

November employment TSP allocation guidePurchasing Managers’ Index (PMI): as usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The November PMI reading of 53.2 is a good, strong number:

Manufacturing expanded in November as the PMI registered 53.2 percent, an increase of 1.3 percentage points from the October reading of 51.9 percent, indicating growth in manufacturing for the third consecutive month. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI above 43.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the November PMI indicates growth for the 90th consecutive month in the overall economy, and indicates growth in the manufacturing sector for the third consecutive month.

The past relationship between the PMI and the overall economy indicates that the average PMI for January through November (51.2 percent) corresponds to a 2.5 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for November (53.2 percent) is annualized, it corresponds to a 3.2 percent increase in real GDP annually.

And here’s a snapshot of the last 12 months:

November PMI TSP allocation guideYield spreads: The yield curve jumped sharply in November. I get this information from the Cleveland Fed, who had this to say:

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next November at 5.88 percent, down from October’s estimate of  9.24 percent, itself a hair below September’s 9.27 percent.  So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.

recession probability thrift savings plan

 

Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased from April to May. The growth rate is what is meaningful here, and you can see that rate remained strong in the chart below:

Money Supply M2 in the United States increased to 13137.50 USD Billion in October from 13070.60 USD Billion in September of 2016. Money

October M2 tsp allocation guide

Conclusion

All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to allocate all of my balances and contributions to the TSP C Fund.

 

2017 Pay Raise

In case you missed it, I did a quick post on the 2017 locality pay rates. If you want to see how much of a raise you are getting next year, you can find that here: 2017 Locality Pay Rates

Recommended Reading for TSP Investors

This month’s recommended book is Irrational Exuberance by Robert Shiller. Shiller doesn’t set out to tell you how to invest, but rather how to think about investing. Shiller did a pretty good job of predicting the bursting of the tech bubble in 2000 and the housing crisis, and won the Noble Prize for economics in 2013 to boot. He is one of the big brains in this space and is well worth reading.

And my favorite past recommendations are all compiled on this page if you are looking for something else to read:

http://www.tspallocation.com/tspresources/#reading

Small Businesses

Once again this month, I want to highlight a very small business which I like and perhaps have a positive impact on them. Sweet Passages is a brand new website for a very high end artisanal chocolate maker. Her product is beautiful food art, so it is a big step up from regular chocolates as a gift, and is also really delicious. I wound up with a box because the chef is a friend of a friend of a friend, and now it will be one of my standard gifts.

The Next Update

I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I have stumbled across for investors, Feds and the military a few times a week at: @TSPallocation

What’s in it for me?

I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

(The first photo in today’s update is the launch of John Glenn and the Mercury Friendship 7 capsule, by the way)

2017 Federal Locality Rates

The President has sent the 2017 alternative pay plan for Federal employees  to Congress. The plan calls for a 1% increase in pay for all Feds, and an average of 0.6% increase in locality pay.

The winners in this year’s locality pay race are Feds in San Francisco (1.32%), Washington-Baltimore (1.26%), and San Diego (1.22%).

Feds in the “Rest of U.S.” (0.39%), Cincinnati (0.41%), and Cleveland (0.45%) fared the worst.

The formula under which locality rates are supposed to be established would have raised those rates by an average of 28.49%, which would cost the government about $26 billion. The law allows the President to depart from that formula in cases of “national emergency or serious economic conditions affecting the general welfare,” a provision which has been used every year since the law was enacted.

But not to fear – according the President’s statement: “These decisions will not materially affect our ability to attract and retain a well-qualified Federal workforce.”

The 2017 locality rates for all areas are listed below:

Download (PDF, 27KB)