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)

A Trump Presidency and the Thrift Savings Plan

11/14/2016
trump-effect-on-tspSo that happened.

Before I get started here, let me reiterate what I said a few times in my last post – 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.

In my last post I talked about what I believed would happen in the stock market in the days and weeks following the election, and noted that at the end of the day none of the possible results should by itself impact the economy’s overall recovery. So whatever happened in the short term as people bought or sold based on their conceptions of what impact a particular candidate would have on the market, over the long term I didn’t see any reason to change my strategy. And even in the short term I thought the effects would be relatively short-lived.

The short term drop and recovery I predicted in the event of a Trump win happened, but much, much faster than I anticipated and it was so quick that most US investors were not impacted by it at all. After it became clear that Trump had won, panic selling ensued around the world and in the futures markets, with the S&P 500 down more than 5%. But by early morning, that loss had been cut in half and by the time the market opened, the removal of uncertainty apparently balanced out the sellers and we opened flat. By the end of the day, the S&P 500 was up 1.11% as institutions unwound their hedges and other defensive trades.

The market had priced itself for a Clinton win, but one close enough that Trump would declare the results illegitimate. A clear win by either candidate was a better outcome for the market which hates uncertainty over just about anything else.

Bottom line(s) up front:

Thrift Savings Plan: there is nothing to indicate there will be a change in the economic conditions on which I base my TSP strategy over the next few months. So for now I am staying with my current allocation (85% C Fund, 15% I Fund). (Note that I have been planning to exit the I Fund for a number of months now and the Trump win makes that even more likely as I will discuss in the “Losers” section ). I will talk more below about what impacts President-elect Trump’s campaign promises could have on the US and global economy over the long term below

Investing in individual stocks: this is a more interesting area in the short term, with certain sectors making strong moves in one direction or the other. I will write a bit below about which sectors appear likely to benefit or be harmed under the combination of a Republican congress and Trump White House.

Separating emotion from investing

trump impact on thrift savings planI had a number of colleagues who were absolutely convinced back in 2008 that electing a “socialist” Barack Obama was going to tank the markets and so they pulled their money out to the safety of the G Fund or F Fund until he could be replaced by a “business friendly” Republican. They now have half as much money in their Thrift Savings Plan as I do. Now I suspect there are some folks on the other side of the aisle who will do the same following a Trump election.

As you will recall from my last post, there is virtually no difference in average stock market performance under Democrat and Republican administrations, with the small edge to the Democrats explainable by any number of other factors which impacted the markets during those periods. So nobody on either side of the political fence should be getting too terribly worked up about the change in party come January.

President-elect Trump, of course, is not your run-of-the-mill Republican. And there is very little to indicate so far whether his administration’s policies will match his stump speech rhetoric or hew more closely to those of the Wall Street and Beltway insiders who appear to be lining up for the key positions in his inner circle.

But even if you are absolutely convinced that a President Trump will be a loose cannon, unleashing chaos domestically and internationally, and no matter how convinced you are that the US has made a terrible mistake, take a deep breath. Remember that our constitution is engineered to limit the damage that single president can do, and our ever expanding economy has weathered wars, depressions, runaway inflation, various bubbles, uncountable scandals and the near-collapse of the financial system.

Elections can mean big, fast short-term swings for stocks and other investments, but they historically have had minimal impact over the long term. Since World War II, stocks have ended up higher under every president except Richard Nixon and George W. Bush.

Notwithstanding the positive performance of the market in the last week, my sense is that we will see a fair amount of volatility in the next year due to the uncertainty which Trump brings to the table. But that’s okay, stocks are long-term investments, meant to be held for many years. Big swings in the interim are normal and should be expected. That higher volatility is the price that investors pay in exchange for the higher returns that stocks provide over bonds and other investments. And the market adjusts to even the most unexpected surprise relatively quickly. Nassim Taleb writes all about the impact of improbable events in his brilliant The Black Swan. And I am confident that we will survive our Orange Swan.

Trump policy impacts on the economy, stock market and TSP

Nobody really knows what sort of policies we will actually see from a Trump administration, but I will run through some of the main points of his platform and share a comment or two on what impact I believe those could have from an investing perspective. This is not meant to be at all exhaustive, and almost none of these issues will turn the economy on their own, so at this point none of these will change my investing strategy.

Trade:

tradeMy biggest concern is that Trump’s election could eventually lead to a global trade war, which would drag down profits for big U.S. companies which depend on customers in China, Europe and elsewhere, and cost jobs at every US company which does business overseas. 40% of the profits of the companies in the S&P 500 (the TSP C Fund) are generated overseas.

The concern is all the more real, because the President has wide latitude to effect trade independently of Congress. The US could pull out of NAFTA six months after notifying Canada and Mexico of intention to do so, and imposing tariffs on imports is also within the powers of the president

Trade is complicated. It is easy to say that you will force companies to build their products in the United States in front of a cheering crowd, but much harder to enact polices to make that happen without unintended consequences. 70% of the parts in Honda CR-Vs assembled in Mexico are made in US factories. Are those CR-Vs good or bad for American workers? BMW (a foreign company) makes 200,000 vehicles every year at a plant in Spartanburg, SC, so that’s good, right? But 90% of the parts used in those vehicles are manufactured overseas, so the plant is bad? But more than half of the vehicles produced in the plant are exported to foreign buyers, so back to good? The globalization of supply and sales chains makes things tricky, doesn’t it?

One of Trump’s most consistent promises on the campaign trail was his pledge to declare China a currency manipulator on his first day in office. That is well within his powers, but would be ironic, because while China artificially depressed its currency for years to boost exports, for the past two years it has actually been propping it up to slow the flow of funds out of China.

There is a very high risk of recession if all the talk ends in a trade war. Protectionist policies may well help workers in a particular industry, but will always create a drag on overall productivity. The results would be depressed profits for US companies and higher prices for US consumers, leading to lower spending, lower capital investment and lower employment.

Immigration:

It remains to be seen whether overall immigration will be reduced under a Trump administration, but population growth is a key input for economic performance from a macro economic standpoint. A reduction of the labor force drives up wages and prices, reduces productivity and reduces potential GDP growth.

The attraction of foreign talent to US companies has been a massive driver of stock market growth, with 40% of US Fortune 500 companies founded by immigrants or their children. Iconic US companies created by immigrants include AT&T, Pfizer, Goldman Sachs, Dupont, Kraft Foods, Colgate, Procter & Gamble, Comcast, and Nordstrom. More recently, immigrants have founded more than half of US startups valued at over $1 billion. Google, Yahoo!, eBay, Uber, Stripe, Tesla, SpaceX, and Palantir all have at least one immigrant founder.

Taxes:

Trump has said he will cut corporate tax rates from 35% to 15%, as well as allow repatriation of money earned by US companies overseas at a 10% rate. Effective tax rates are much lower for most companies so the windfall would be less than it appears, but both of those actions would still provide a major boost to the earnings of large US corporations.

Any such tax cut is dependent on congressional action, however, and even with Republican majority in both houses would likely require some difficult tradeoffs. Most problematic is where the money would come from to replace those tax revenues. All Trump has said so far is that higher economic growth will make up the difference, but that’s hard to bank on.

Infrastructure:

There have been wildly different numbers depending on the speech, but it seems to boil down to a $500 billion to $1 trillion surge in spending on infrastructure paid for with a combination of debt financing and tax credits. If it happens, this would be the fiscal policy half of the equation which has been missing from the recovery and would be great for the economy. Boosting spending leads to new investment and hiring, which prompts further spending in a virtuous cycle.

That spending and an increase to the debt ceiling would have to make it through the Republican controlled Congress, however, where members have been stridently opposed to spending increases.

Debt limit:

Speaking of the debt limit, the federal borrowing limit will have to be raised by next summer to avoid default. Republicans have been loathe to raise it in recent years for political appearance and relied on Democrats and Republicans in very safe seats to raise it, even though it is absolutely necessary and completely meaningless in a practical sense. Now that the Republicans own the the government, it will be interesting to see if this sails through or if we will go up to the deadline again. The last time we did, it was bad for the market, although we recovered fairly quickly.

Individual stock investing after the Trump win

From a very short term perspective, this was a great week for me. Rough mental arithmetic puts my paper gains since the market opened last Wednesday morning well north of $100,000. The overall market’s move up was nice, but it was the performance of certain sectors which really made a difference. I have a disproportionate percentage of holdings in the tech, pharmaceutical/bio-tech, financial and oil sectors. Tech has responded poorly to the Trump victory, but the stocks of drug companies, banks and oil companies have all run up nicely in anticipation of friendlier treatment at the hands of a Trump administration than a Clinton administration.

I will very briefly run through the sectors which appear most likely to be impacted by the Trump victory, some of which may be more perception than reality.

Winners:

Defense stocks: Trump has called for increased spending on the military, which translates to increased profits for weapon manufacturers and defense contractors.

Pharmaceuticals: Trump is viewed as being in favor of less regulation, while it was expected that Clinton would have tried to crack down on rising drug prices. Drug company stocks have skyrocketed since the election, with some of my holdings up 20%.

Oil: Trump has come out in favor of loosening restrictions on the energy industry and reducing regulations on drilling. That could bode well for energy companies which produce fossil fuels as well as service companies which support them.

Banks: Trump has been all over the map on banks – talking about breaking up big banks in the same speech in which he talks about loosening regulations and restrictions. So far the market seems to believe his more traditional Republican policy guides will win out and the big banks will have fewer restrictions over the next several years.

Construction equipment manufacturers: Caterpillar and the like will benefit if the US goes on an infrastructure building binge

Losers:

Health insurers and hospital systems: if Obamacare is fully repealed and 20 million Americans are removed from the ranks of the insured, that will mean significantly less business for insurance companies (which to be sure are still struggling to figure out how to price coverage for their new customers) and hospitals (which were making a lot of money from these newly insured patients). A lot will depend on what the Republicans replace it with.

Renewable energy: solar and other renewable energy producers will suffer from lower oil prices, fewer restrictions on coal for electricity generation, and reduced subsidies.

Car manufacturers: US manufacturers can compete on price with Asian and European companies only because they moved low skill, high labor tasks to cheaper locations. If the North American automotive industry’s supply chain is broken up, prices for US cars will jump. And that doesn’t even take into account higher tariffs for vehicles exported from the US if a trade war breaks out.

Exporters: Trump would need to work with Congress to modify long-standing trade deals, but if he succeeds it would result in losses for companies that export heavily to other countries. And most large US companies are exporters – remember I noted above that a full 40% of the earnings of companies in the C Fund are generated overseas.

International stocks: Emerging markets will suffer the most, but developed markets will be hurt as well. Drags on foreign companies and economies include repatriation of overseas profits pulling money out of foreign subsidiaries, “soft protectionism” including local content requirements for publicly funded projects, and a strong dollar resulting in tightening of foreign financial conditions (foreign companies race to pay down dollar denominated debt because it is more expensive to pay off instead of investing and growing). Trump’s election will likely provide a boost to other populist politicians who will favor protectionism in their own countries, with elections coming up in Italy, the Netherlands and France. About 14% of Europe’s exports go to the US, and even a modest decline could be enough to tip the Eurozone into recession.

Conclusion

I know that’s a little all over the place, and certainly not conclusive in one direction or the other. But that’s the nature of the stock market – we really can’t predict what is gong to happen, just have a general sense of what the possibilities are and try to make decisions based on the probabilities. A trade war would likely have fairly quick effects on the economy, but anything else should show itself in the indicators over a period of time so I am content to sit back and wait for the data to come in.

Small Businesses

stollenIt occurs to me that with my follower count well into five figures, I have the ability to point a few readers towards small businesses which I like and perhaps have a positive impact on them. With that in mind, this month’s favorite small (super small) business is the Dresden Stollen Bakers. They bake stollen Christmas bread for one week each year, and it has become a wonderful tradition for my family. They don’t have any idea who I am and I’m not getting anything for recommending them, just something I like. The last day to order for Christmas 2016 is November 15, so don’t dawdle.

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!

November 2016 Update – Presidential Election Special

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

11/04/2016

tump-clintonI was too busy packing for my post-election move to Canada to get out an update in October, but no worries – the recovery continues to trundle along and there was nothing of particular note in the economic news last month. Mostly more of the same, with a slight tilt towards an acceleration in the recovery, as data showed GDP growing a a faster pace than it has been and signs that inflation may be picking up.

I know that many Thrift Savings Plan investors are very nervous about the presidential election and its potential impacts on their nest eggs, particularly given the string of down days we have had over the last week and a half. So today’s update is all about the election. Don’t worry, this is a strictly non-partisan webpage and there won’t be any political views. Please don’t mistake anything I write below as favoring one candidate over the other.

Today I will cover: (1) what is causing that losing streak, (2) how the markets typically react to elections, (3) whether the stock market predicts election results, and (4) what I think is going to happen over the next week and through the end of the year.

Longest Losing Streak since 2008

Everyone has been so distracted by politics that almost nobody has noticed the S&P 500 has fallen eight days in a row. That’s the longest streak since the Financial Crisis. If we hit nine down days in a row that will be the longest losing streak since 1980.

It all sounds very dramatic, but the fact is that it has been a very mild decline, falling just 2.9% in that period.

So what caused the drop? See number 1 in the section below.

Elections Impacts on the Stock Market Historically (the good old days)

cinton-trump-good-old-daysTake it with a grain of salt if someone marks up old stock market charts to show when elections occurred and tries to draw conclusions. Remember that the market is continuously evolving and looks nothing like it did 25 years ago, much less 100 years ago. And remember that there were a lot of other things going on impacting the market besides the election (most notably the business cycle, which really couldn’t care less who is in the White House). It is also very easy to cherry pick data so you get the result you want – for example I can convince you that either Republican presidents or Democrat presidents are better for the stock market by just switching which index I’m using or using a slightly different date range.

But for what it is worth, here are some nuggets from history:

(1) The number one lesson is that the market responds much better to elections where the outcome is predictable. That makes sense, because if there is one thing the market hates, it is uncertainty. That’s why the market was so steady, trading in a tight range for almost three months as Clinton started to look like a sure thing. But it has been sputtering since Director Comey sent his letter to Congress and Trump came back a bit in the polls. Uncertainty is a self correcting issue, but not until November 8.

(2) There is more uncertainty this cycle because the incumbent isn’t running. Since 1928, the S&P 500 has dropped an average of 2.8% in the final year of a president’s second term. Compare that to the average return of 12.6% in years in which the incumbent is running for reelection.

(3) In years in which the incumbent can’t run, the market does markedly better if the incumbent’s party wins the election than if the incumbent’s party loses.

(4) The market rises an average of 6% in the first year of a presidential term, a little lower than the 7.5% average for all years. The market typically does better in the second half of a president’s four year term than the first, with the last seven months of the president’s last year being positive in all but two election years since 1952.

(5) When you look at what the most successful  combination of who is president and who controls congress are, the rankings from best to worst are as follows:

  1. Democrat President/Republican Congress
  2. Either party controls both White House and Congress
  3. Either party in White House/Split Congress
  4. Republican President/Democrat Congress

(6) And finally, under which party has the stock market done better? There are a lot of different studies out there, most of them coming out with a statistically insignificant advantage to the market under Democrats when corrected for market volatility. And that advantage is so small it is meaningless compared to other normal market return variations. For every study which shows that one party is better than the other, you can change the date range slightly or measure a different index and come out with the opposite result.

Does the market predict the results of the election?

Historically, if the stock market is up in the three months leading up to the election, the incumbent party wins, whereas stock market losses over those three months tend to predict the opposition party will win. In the 22 presidential elections since 1928, 14 were preceded by gains in the three months prior. In 12 of those 14 elections, the incumbent (or the incumbent party) won the White House. In seven of eight elections preceded by three months of stock market losses, the incumbent party lost. That means the S&P 500 has an 86.4% success rate in forecasting the election.

This is an interesting fact, but the folks who crunch numbers for a living will tell you that this isn’t a large enough sample to be at all conclusive and it obviously ignores all of the other factors which go into the stock market and presidential elections.

But just for fun, what does this indicator mean for the 2016 election? A few trading days out from the election, that measure is too close to call. Over the past three months the S&P 500 is down 0.73%. It can change that much in a few minutes, so unless something changes in the next few days, the market won’t be making a strong call one way or the other on this one.

The Crystal Ball

There are three possible outcomes: clear Clinton win, close call either way, and clear Trump win.

Clinton Win: My prediction is that Clinton wins with a large enough margin in the Electoral College that there is no dispute and nobody calls for statewide recounts in the presidential race, followed by Trump conceding more or less gracefully. If you go back just a few months, you will see that I was wrong about which way the BREXIT vote would go, and it is entirely possible that I will be just as wrong here as well.

I don’t think the election is as close as the media wants you to think it is. CNN will make over a billion dollars in ad revenue on its election coverage over the past 18 months. They don’t keep people tuned in by saying it is all-but-over if you look at the electoral college numbers. They get you to watch commercials by putting up tickers showing the results of some poll which doesn’t really tell us anything about the actual election.

The impact of a clear Clinton win would be the market breathing a sigh of relief to the upside, and I think we would see a few percentage point gains between now and the end of the year.

A Hanging Chad: The next most likely alternative is a close election, with either Clinton or Trump winning. Both parties have armies of lawyers standing by in each of the swing states, so if they are separated by just a few electoral votes I don’t think we will see either one concede on November 8. That would be fantastically stressful for the stock market (see above where we talked about how the market hates uncertainty), and I would expect to see the market move lower until the results become clear, at which point we will see a recovery. If I thought this was likely, I would move to the G Fund until the drop and then buy the C Fund back at a lower price.

Trump Wins: Finally, and least likely in my estimation, is a clear Trump victory. The Republicans just start with too deep a hole in the electoral college to make mistakes, and Trump doesn’t appeal to a broad enough swath of Americans to overcome that disadvantage. But just as with BREXIT, I could be wrong, and Trump could become the President-elect on November 8.

If that occurs, I believe we would see a fairly sharp market correction as all the experts who were quite certain Clinton would win see themselves caught on the opposite side of the bet. I would expect the correction to be between five and ten percent. And that would be a very good buying opportunity, because (just as with BREXIT) it would quickly become apparent that the world would not end and that the President doesn’t actually have much control over the economy. So I expect the market would recover relatively quickly and the market would end the year about where we are now or perhaps just a bit lower. As with the Hanging Chad possibility, if I thought this were likely I would move to the G Fund and buy back in at a lower price after the drop.

As I mentioned before, this is a strictly non-partisan blog and the predictions I made aren’t based on any political views I hold, just what I think will happen based on what I have read. So please don’t unsubscribe if I predicted the team you are pulling for might lose.

So what does that all mean for me?

As with the vast majority of “THE MOST IMPORTANT THING EVERs”, I don’t think the election will impact the economy over the short or medium term. So I am staying exactly where I am and not changing my allocation. The next week will almost certainly be volatile, but that only affects me if I sit and stare at CNBC all day. Over the long term, I believe this is just going to be a little flat spot on chart which otherwise points up at a very nice angle.

5-year-s-and-p-500-chartThe 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!

Current Thrift Savings Plan Allocation and Business Cycle Analysis – September 2016

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

09/24/2016

The Market Awakens

 

tsp-shows-signs-of-lifeSince my last post, the market woke everyone up with a decent one-day drop in early September, but then quickly pulled back to even and pushed ahead. Since August 1st, the C Fund is up 0.66%, the S Fund is up 2.44%, and the I Fund is up 3.65%.

There frankly isn’t much to talk about in the US markets this month. Economic data came in pretty much where it was expected and our slow-roll recovery continues to trundle along. I think the market has a better sense now of what the Fed is going to do over the next year (likely a rate hike at their December meeting and then a goal of two to three more in 2017), which is good for some stability.

So after I run through the August economic numbers for the US, I will spend a lot more time than I usually do talking about the I Fund, it’s fantastic run since the Brexit vote, and why its run in my Thrift Savings Plan is nearing an end.

Thrift Savings Plan Fund Returns

The TSP funds all had a very lackluster August:

  • TSP C Fund:  0.14%
  • TSP S Fund:  0.80%
  • TSP I Fund:  0.08%
  • TSP F Fund:  -0.11%
  • TSP G Fund:  0.13%

But this is shaping up to be a very solid 2016 (year to date through 09/23/2016):

  • TSP C Fund:  8.27%
  • TSP S Fund:  10.69%
  • TSP I Fund:  4.15%
  • TSP F Fund:  5.84%
  • TSP G Fund:  1.28%

August’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 151,000 in August, and the unemployment rate remained at 4.9 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.

tsp-allocation-guide-jobs-august-2016Purchasing 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 August PMI reading of 49.4 dropped a bit from last month, but not enough to make anyone nervous:

Manufacturing contracted in August as the PMI registered 49.4 percent, a decrease of 3.2 percentage points from the July reading of 52.6 percent, indicating contraction in manufacturing for the first time since February 2016 when the PMI registered 49.5. 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 August PMI indicates growth for the 87th consecutive month in the overall economy, while indicating contraction in the manufacturing sector for the first time since February of this year. The past relationship between the PMI and the overall economy indicates that the average PMI for January through August (50.9 percent) corresponds to a 2.4 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for August (49.4 percent) is annualized, it corresponds to a 2 percent increase in real GDP annually.

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

tsp-allocation-guide-pmi-august-2016Yield spreads: The yield curve was unchanged in August. I get this information from the Cleveland Fed, who had this to say:

With no change in the spread, the impact on predicted real GDP growth was minimal. Using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.5 percent rate over the next year, even with the July number, and down a bit from the 1.7 percent seen in June. Although the time horizons do not match exactly, the forecast is at a similar level as other forecasts, and like them, it does show moderate growth for the year.

Not surprisingly, the probability of recession didn’t move much either. 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 August at 11.25 percent, just below July’s 11.28 percent, which was up from June’s estimate of 9.58 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.

tsp-allocation-guide-recession-probability-august-2016

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 12733 USD Billion in May from 12652.20 USD Billion in April of 2016.

TSPAG money supply May 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 maintaining the bulk of my investments in the TSP C Fund.

The TSP I Fund

I have been assuming that I would find an exit point from the TSP I fund every month since the Brexit vote, but it is up 13.37% since June 27th so I have stuck with it. 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.

So why is the I Fund up 13.37% in less than three months? As you can see in the chart below, about half of that gain can probably be attributed to the rebound following the market’s overreaction to the surprise vote by the UK to leave the European Union. The I Fund was back to breakeven in less than three weeks.

tsp-i-fund-returns-post-brexit

Since then, the I Fund has continued to outperform, as you can see on this chart of the TSP Funds’ performances since July 11th:

I really wish I could explain that late July into early August separation between the I Fund and the US stock funds, because then I could project when that might happen again. But short term moves in the market are virtually impossible to predict and even in hindsight are very hard to explain. What we do know is that when all the money which had been on the sidelines came pouring back into the market after the Brexit decision, a disproportionate amount went into international stocks, both developed market (the I Fund) and emerging markets. Some analysts will tell us that happened because the US market was “fully valued” or even “overvalued” as it was considered a safer place for money during the chaotic early part of 2016, so when the floodgates opened investors went after “undervalued” stocks overseas where they saw the potential for higher gains.

That valuation argument ties in pretty well with why I moved a part of my TSP allocation to the I Fund in July 2015. When I moved 15% to the I Fund, one of the key reasons was the I Fund was significantly undervalued from a price to earnings ratio standpoint. (You can read that post here.) I said at the time:

I like the TSP I Fund from a valuation standpoint compared to the US alternatives. I think it has room to expand several percentage points as investors’ faith in the European recovery is renewed, whereas the TSP C Fund is several points over its historical average P/E ratio.

The I Fund’s valuation has changed significantly during the recent run-up, bringing the valuation to virtually the same as that of the C Fund:

Fund   -   Price/Earnings Ratio   July 2015    Sept 2016

TSP C Fund (VOO ETF as proxy):     20.79           22.1

TSP I Fund (VEA ETF as proxy):     15.94           21.3

With that valuation gap eliminated, I don’t see any remaining argument for keeping the I Fund in my Thrift Savings Plan allocation. The other factors when I made that decision were (1) where the main countries which make up the I Fund were in their recoveries, (2) the end of political uncertainty in Europe, and (3) the stimulus being applied by the European and Japanese central banks.

Those other factors in order:

(1) Where the main players in the I Fund are in their business cycles: I look at the economic indicators for Japan, the UK, Germany, France and Switzerland (which comprise the bulk of the TSP I Fund) each month to look for a direction for the I Fund over the medium and long term. I won’t go through each country, but in summary I don’t see anything particularly positive about those numbers at this point.

(2) The quieting down of European Union politics: When I wrote that line the Greek crisis had just been resolved and I didn’t see any major threats to tranquility in the EU for the next several years. I couldn’t have been more wrong about that. I don’t see any scenario under which Brexit implementation over the next few years is going to strengthen the economies of Europe and the UK, and it is going to create a great deal of uncertainty.

(3) Economic stimulus by the Europeans and Japanese: The European Central Bank (ECB) just had a great opportunity to hint that their current stimulus program which runs out early next year will be extended, but chose not to do that. There are too many cooks in that kitchen for a very aggressive plan, and while I think the ECB can provide support it won’t be enough to break the European economy loose unless fiscal policy (government spending) is added to the mix.

Japan is going full bore with both a fiscal and monetary policy. In early September they announced their largest ever stimulus package which includes everything from major infrastructure projects to cash handouts to low-income people. That may yet have an effect, but it is going to be tough to counteract their aging and shrinking population.

Conclusion: It is time for me to get out of the I Fund. It may well continue to outperform the C Fund over the short and medium term, because anything can happen during that time frame. And it may even outperform over the long term, but I think the risk of big losses outweigh the potential gains.

So since I don’t see any strong arguments under these circumstances for taking the enhanced risks associated with being invested in the I Fund, why haven’t I sold? If I were a purist, I would put in my TSP interfund transfer and allocation change orders right now. But some part of me is still a momentum investor and wants to see if the I Fund’s run will extend from here, particularly since I have such a small percentage of my TSP balance in the I Fund. So I will do exactly what I usually preach against and wait to see what the market does week by week until I decide the money inflows have evened out.

I will, of course, put out a very short update when I do make that allocation change and intrafund transfer – not because I think any of you should be following my lead, but to be transparent and add to the community’s discussion.

Recommended Reading for TSP Investors

The best book I read this month is geared towards leadership and building happy, productive teams: Leaders Eat Last: Why Some Teams Pull Together and Others Don’t by Simon Sinek. Sinek has studied effective organizations and pulled together scientific research to try to explain why some teams and units work, and others don’t, with the goal of explaining how you can create a team “where almost everyone wakes up inspired to go to work, feels trusted and valued during the day, then returns home feeling fulfilled.”

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?

tsp-talk-investing-adviceI 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!

Current Thrift Savings Plan Allocation and Business Cycle Analysis – August 2016

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

08/28/2016

Endless Summer

tsp talk summer low volume

Since my last post, the market has continued to trickle up, quietly setting new all-time highs on each of the major indices in the process. All three of them (the S&P 500, DOW and NASDAQ) actually hit all-time highs on the same day a few weeks ago for the first time since the last trading day of 1999.

I’ll bet the obnoxious “sell in May” advocates in your office are keeping very quiet this year. Feel free to rub the recent financial headlines in their faces, and if they protest that this year is an aberration, point them towards this post.

More notable than the recent highs has been the lack of volatility. Typically, if the market is going to make a sharp move, that move is going to be downwards. But in the last 42 trading days the S&P 500 hasn’t declined by more that 0.7% a single time.

Sentiment is poor, we are suffering through a ridiculous election season, Brexit happened, Zika is looming, there is a terror attack somewhere in the world nearly every day – why does the market keep going up? Because behind all of that there has been a steady stream of solid economic news both here in the US and globally, and, more importantly, because there is no alternative to the stock market.

TINA (there is no alternative) means that with interest rates held near zero, there is nowhere else to go for return on your savings. You can’t put it in a bank account, money market account or a bond fund, because you don’t get anything back. This is worst period imaginable for the folks out there who see the stock market as a gamble and never learned to invest, or the folks who got scared away from it for life after seeing some paper losses during one crash or another. They are going to be left behind. But for the rest of us, every pay period some sizeable chunk of our paycheck goes into our retirement accounts and has to go somewhere. And the same thing is happening in tens of millions of other households in the US. And in a few hundred million households around the world. And companies are paying dividends and governments are printing money. And all of that has to go somewhere, and there is no alternative, so that money keeps pumping into the stock market.

Don Q TSPSome pundits will tell you that if we are at new highs, surely that means the market has to correct or we are due for a downturn. A correction is always a possibility (and over a long enough period, a certainty). I’m sure we will see one or more in the next few months, but good luck predicting when. I’m pretty sure Peter Lynch was right when he said “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has ever been lost in corrections themselves.”

The other argument you hear a lot is that the stock market is overvalued, meaning that the price to earnings ratio (P/E) is considerably higher than its historic average. P/E is one of the very basic measures for a stock or a group of stocks (an index), and just reflects how much investors are willing to pay for $1 of earnings per share by a company (or the average of all the companies if the P/E is for an index). So if IBM is trading for $100 a share, and it earned $10 a share over the last year, IBM has a P/E of 10. Simple right?

Right now the P/E ratio for the TSP C Fund is almost 25. Which means that on average, investors are willing to pay $25 for every $1 of earnings per share for all of the companies in the S&P 500. That is significantly more than the historical average, which is around 16, which is why some of the talking heads on TV are announcing that we are in a bubble. Over time the expectation is that either earnings have to rise or share prices have to fall to bring our number back towards the average.

But as usual, it’s not that simple. There are a lot of different ways to measure the valuation of the market. Many people believe it is better to look at ten years of trailing earnings (the Shiller P/E) instead of one. The Shiller P/E is currently at 27. And I generally believe that any averages before the advent of the modern stock market are fairly worthless. When you look at it in that context, the Shiller P/E’s average since 1987 of 24 is not significantly below where we are now.

And of course there are lots of other numbers out there which we can slice and study as we try to figure the market out. Last month we talked about the ratio of the S&P 500’s P/E ratio to treasury bill yields, by which measure stocks appear significantly undervalued.

Stock market valuations are too short term to be a factor in my TSP investing decisions, so I write about these issues here just to try to explain some of what you may be hearing or reading, not because I think we should worrying about them.

TSP Fund Returns

The TSP funds all had a good July:

  • TSP C Fund:  3.69%
  • TSP S Fund:  5.40%
  • TSP I Fund:  5.07%
  • TSP F Fund:  0.64%
  • TSP G Fund:  0.13%

And this is shaping up to be a pretty good year to date (through 08/26/2016):

  • TSP C Fund:  7.71%
  • TSP S Fund:  8.80%
  • TSP I Fund:  1.72%
  • TSP F Fund:  5.71%
  • TSP G Fund:  1.17%

July’s Economic Numbers:

In this section I typically 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.)

It is already the end of August, so these July numbers are dated and I’m just going to give the cliff notes version again this month:

Employment numbers: the numbers again blew out estimates with approximately 255,000 jobs created. That number may be setting us up for an interest rate hike from the Federal Reserve before the end of the year.

Purchasing Managers’ Index (PMI): the PMI was down slightly from last month, but was a very solid 52.6 (which is well above the range where we start to get concerned).

Yield spreads: the yield curve flattened slightly in July, but according to the Chicago Fed’s model the chances of a recession in the next year based on the curve is still only about 11%.

Money supply growth rate: Money Supply M2 growth rate increased again last month. Very solid number.

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 maintaining the bulk of my investments in the TSP C Fund.

I might as well repeat exactly what I said last month about my 15% allocation to the I Fund. I have been looking for an exit point, but since the Brexit vote the I Fund is up 11.44% compared to the C Fund’s 8.83%, so despite my misgivings about the I Fund going forward, I haven’t been in a hurry to sell. It is dumb for me to try to guess what the market is going to do short term and goes against the long term investing strategies I advocate.  I will try to really dive into the I Fund’s component bits in next month’s update.

Military TSP Investors

An increasing percentage of new subscribers to this blog are signing up with military email addresses. That is great for any number of reasons, not least of which is I grew up in a military family and was in uniform myself for a few years. I hope that this site will be a useful resource for many of them, particularly because many military investors are younger, have little or no investing experience, and many come from backgrounds where investing was not a subject of daily conversation (as is true of most of the US population). All of those factors leave them very vulnerable to bad advice and unscrupulous actors.

My father retired from a 28-year military career with well over a million dollars in investments, and that was back when a million dollars was still a lot of money so I’m sure his nest egg was at least double that in today’s dollars. So signing up for a military career doesn’t mean taking a vow of poverty. It certainly helped that my mother also started working once the kids were out of elementary school, which was a bit unusual in the military during that period. They did it by making saving and investing a priority and making smart, long term investing decisions. They were reasonably practical, but certainly not cheap, and they amassed that nest egg while still managing to pay for new cars, boats, family vacations and college educations for a couple of lousy kids. So it can be done, and there are much better tools and opportunities available to military investors today than there were when they were doing it.

I have been intending to increase my outreach to the military community as we get closer to the January 1, 2018 date when the new blended military retirement scheme kicks in and troops gets the option of a 5% match and the 1% automatic contribution in their Thrift Savings Plans. It is estimated that change will bring about 750,000 new military TSP accounts online. So to get that started, I have two requests of you:

  1. Please share this blog with your friends and colleagues in uniform. I  estimate that roughly half of my new subscribers come from Google searches and the other half from word of mouth. You can be that mouth.
  2. If you have a favorite source of information which provides information for the military on benefits and retirement, please point me towards it. I would love to start forming relationships with some other people who write for a military audience the way I have on the civilian government side of the house. (And so much the better if you are such a resource, or if you know someone in that position who you can introduce me to virtually).

There are very few differences between the military Thrift Savings Plan and the one enjoyed by the rest of us (mostly centered around special tax benefits available to those serving in combat zones). By the end of the year I hope to get a page up on this site which breaks out the special considerations military TSP investors should be aware of.

Recommended Reading for TSP Investors

I didn’t actually read any books on investing since the last update, so nothing new to recommend today. My favorite past recommendations are all compiled on this page if you are looking for something 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?

Dilbert 401KI 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!

Current Thrift Savings Plan Allocation and Business Cycle Analysis – July 2016

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

07/18/2016

Brexit and the TSP

Brexit and the TSP

So there you have it – the Brits voted to leave the EU, we had a rather predictable short-term panic sell off, and then the market came roaring back with the strongest run we have seen in recent memory (in the last 14 trading days the market has closed higher 12 times). All capped off by the S&P 500 hitting an all time record, and then breaking that record several more times.

Breaking that down a little bit more, in the two trading days following the Brexit vote the TSP C Fund declined 5.34% and the TSP I Fund declined 10.6%. But in the three weeks from the market’s low close on June 27 to today, the C Fund is up 8.19% and the I Fund is up 8.58%

That all makes me look awfully prescient – in last month’s update I said that if they voted to leave we would likely see a short-term sell off, with the I Fund down by at least 10%, followed by a relief rally. Please don’t be fooled, however, as that’s a pretty lucky call to which I would attribute 10% experience in watching the market for a couple of decades now, and 90% pure dumb luck. Because at the end of the day, “nobody knows nothing” short term.

In case you missed last month’s discussion about the Brexit and how I believe it impacts TSP investing, you can find that here: http://www.tspallocation.com/thrift-savings-p…alysis-june-2016/

Halfway through 2016

We have reached the midpoint of 2016, so let’s take a look at the TSP fund returns year to date (through 07/18/2016):

• TSP C Fund:  7.33%
• TSP S Fund:  6.89%
• TSP I Fund:  -0.74%
• TSP G Fund:  1.01%
• TSP F Fund:   5.57%

What comes next?

The US Markets

I think we will see relatively steady economic growth for the rest of the year, and both oil prices and the US dollar will stabilize and normalize to some extent, which will reduce the drag those factors have had on corporate earnings. Interest rates will remain low – I would not be surprised to see the Fed raise rates once in the Fall (but no more than that) – which provides support for higher stock valuations because bonds will be relatively unattractive compared to stocks. I frankly don’t see a domestic risk to the US economy over the remainder of the year. Key global risks which could certainly impact the US economy include the debt crisis which will hit China at some point in the coming years and additional threats to the cohesiveness of the European single market.

I expect the current stock market run to flatten out and for us to see a correction in the 5% range in the next month or two. (Long time readers will remember we see a 5% correction on average every 2.5 months, so I will almost always be correct when I make this prediction.) At this stage in the business cycle we typically see mid-single digit annual returns in the S&P 500 (the TSP C Fund), so it would be somewhat surprising to see the second half of the year repeat the relative strength of the first half and a total return of much over 10%. I think the C Fund remains the right place to be, and if I was guessing (and that’s all we can do when we try to predict the market over such a short period of time), my hunch is that we will see a total return for the year in the high single digits.

There is a lot of talk in the financial media about the stock market being “over valued” these days. It is a bit more complicated than comparing the S&P’s current price/earnings ratio (P/E) (which is around 23) to the historical median (which is 16.9 over the past 50 years). Certainly by that measure the market is overpriced, but this is a very different market than the historical norms we are comparing it to.

Another number to look at is the ratio of the S&P 500’s P/E ratio to treasury bill yields, by which measure stocks appear significantly undervalued. That ratio typically stays within a very tight range. The median ratio from 1968 to the present is 0.61, with anything over 0.7  historically predicting a double digit annual gain. Right now the ratio is ten times that, at about 7.5.

The predictions made by of those ratios will be bandied about by their proponents as inviolable laws of finance. The truth, I’m sure, is somewhere in between. And as much as we like to find patterns in the past, the market is made up of a huge number of factors and is constantly evolving.

International Markets

brexitingBrexit is important to me because UK companies represent about 20% of the TSP I Fund and there is an excellent chance that the UK will tip into at least a brief recession over the next few quarters. Exports from the UK to the EU account for 47% of the country’s total exports, while 55% of UK imports are coming from the EU. The UK’s dependence on trade with Europe makes the terms of their exit extremely important to the UK economy going forward. The exit vote has not only created near-term market uncertainty, but has raised genuine fears about the future of the EU. This increased uncertainty and higher than anticipated currency volatility make investments in the developed international markets less attractive over the rest of the year for me.

The uncertainty is a big deal for the UK, Europe and probably the I Fund, but I don’t see a significant threat to the global economy and impact on the US recovery. The UK has the fifth largest economy in the world, but its gross domestic product (GDP) as a share of the world total is only 3.7%. And the UK’s trade share in the global total is relatively minuscule, accounting for 2.8% in world exports and about 4% in global imports.

This Month’s Economic Numbers:

In this section I typically 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.)

It is getting late and if I don’t get this out tonight, it probably won’t happen before next weekend so I am going to dispense with all the fancy charts and analysis and give the cliff notes version this month.

Employment numbers: the numbers blew out estimates by about 120,000 jobs with approximately 280,000 jobs created. That should largely ease concerns about last month’s very poor number.

Purchasing Managers’ Index (PMI): the PMI was very strong, coming in at 53.2.

Yield spreads: the yield curve stayed roughly the same last month.

Money supply growth rate: Money Supply M2 continued to grow at a solid rate.

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 maintaining the bulk of my investments in the TSP C Fund.

I have been looking for an exit point for my investment in the TSP I Fund. The I Fund outperformed the C Fund during the bounce back after Brexit, but I don’t have a basis for confidence in that index moving forward and will go to an allocation of 100% C Fund at some point in the near future, perhaps as early as this week. There is no science to when I am going to make that move (and I should probably do it tonight just to spare myself the trouble of sending out another update), but I will give it another day or two to see how it appears to be trending.

Recommended Reading for TSP Investors
This month’s recommended book is The Bogleheads’ Guide to Investing. I sort of hesitated to recommend this book because the Bogleheads can be a bit extreme, bordering on cultish, but there is a tremendous amount of value in this book for any investor. I would just caution that this is based on the investing wisdom of John Bogle who is absolutely world class, but has an understandable bias towards buying and holding mutual funds and ETFs – understandable because that is exactly what John Bogle was selling as the founder and CEO of Vanguard. Absolutely great stuff and great advice for the man on the street who doesn’t have the time or inclination to do anything other than passively participate in the market.

My past recommendations are all compiled on this page if you want to browse other topics and titles: http://www.tspallocation.com/tspresources/#reading

The Next Update

I expect that I will be sending out an update before next month when I perform an interfund transfer and change my allocation to 100% C Fund. 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?

TSP adviceI 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!

Current Thrift Savings Plan Allocation and Business Cycle Analysis – June 2016

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

06/20/2016

TSP advice I fundHappy first day of Summer!

This month I am going to write about the potential effects of this week’s Brexit vote the Thrift Savings Plan. Brexit (British Exit) is a referendum on Thursday in which Britain will vote on whether or not to leave the European Union.

In other news, the web hosting problems seem to be behind us at this point. The site is much faster and has not been going down since I moved it to the new server. If you have any problems accessing the page, please do let me know.

Bottom line up front: I do not plan to change my TSP allocation this month, although there is the potential for a fair bit of volatility as I will discuss below.

TSP performance year-to-date (through market close on 06/17/2016):

• TSP C Fund:  2.45%
• TSP S Fund:  1.89%
• TSP I Fund:   -4.31%
• TSP G Fund:  0.86%
• TSP F Fund:   4.69%

And the TSP LifeCycle Funds are very average for 2016 so far (just as they are engineered to be), ranging from 0.60% to 1.08%.

Brexit and the TSP

Brexit and the Thrift Savings Plan

The financial media will be having a field day this week over the vote on June 23rd which will determine whether or not Britain leaves the EU. They will very cheerfully announce that the global economy will almost certainly fall into a deep recession from which it might never recover if Britain leaves. And they will be so cheerful, because drama draws viewers/readers/clicks, and those generate advertising revenue.

What is happening in London right now is the result of an effort which started in the 1970s to unify Western Europe into a common market and trading block. That part worked really, really well – the EU is the largest economy in the world, the world’s largest trading block, ranks first in both inbound and outbound international investments, and is the top trading partner for 80 countries (by way of comparison, the US is the top trading partner for 22 countries). As one of the wealthiest countries in the EU, England benefits tremendously from free trade within the EU as well as the trade agreements between the EU and the rest of the world.

queen backs brexitSo why on earth would the Brits want to leave? The problem is the Europeans just couldn’t limit themselves to creating a common market and monetary union, instead they tried to create a quasi-super nation with it’s own foreign relations, a legislature which can issue regulations which override conflicting laws in the member countries and three separate court systems which weigh in on sensitive issues such as criminal justice, human rights and immigration. It has evolved into a entity somewhere between a confederation and a federation.

The EU has also grown. From six founding states (all of whom were the sort of European countries who the average Brit felt they could relate to), to 28 (including many nations so far flung that many Brits couldn’t find them on a map, and with whom they feel no common bond).

An unhappy confluence of politics and current events has led to the referendum. While the leadership of both main political parties support staying in the EU, a significant number of Conservatives support leaving. The British version of the Republican Tea Party wing has been leading the charge, with appeals to anti-immigrant and “Britain first” sentiment among the elderly and working class.

A key component of EU membership is a requirement that countries allow free movement of EU citizens between member states. The working class has railed against this provision since the EU was created, convinced that waves of Eastern Europeans were coming to take their jobs. (And they aren’t all wrong, the vast majority of hourly wage workers who I meet when I am in the UK are from other parts of Europe). But more recently, the fear is that the huge numbers of refugees and migrants from the Middle East and Africa who have been pouring into continental Europe will soon have their EU passports and will be free to relocate to London.

Nobody took any of this very seriously until recently because “remain” was leading comfortably in the polls and the political leadership couldn’t believe that something this monumental could happen without their support. But over the past month the polls drew even and “leave” took the lead for a period. The latest polls from this weekend have “remain” ahead by a percentage point or two, but it really is much too close to call.

brexit-the-movie-536238
So what happens to the TSP funds if Britain leaves the EU, and what happens if it stays?

Short term, I frankly believe we will see a relief rally in the stock market either way. The market hates uncertainty, and it has shown time and again that it just wants a decision on big issues. Then, whatever that decision is, the market pretty quickly gets on with worrying about whatever the next big thing is. It is possible we will see a short term drop if they vote to leave, and that would not cause me great angst – I would use it as a buying opportunity.

Longer term, the financial media would have you believe that if Britain votes to leave (1) a financial panic will ensue, (2) the British economy will immediately fall into recession and take Europe and the rest of the world with it, and (3) other shaky members of the EU will bail, leaving a few socialists and cheese eaters governing themselves into the ground from Brussels.

What would really happen is an era of uncertainty. Even if Britain decides to completely leave the EU, that would take place over a period of years and after long negotiations.

That total break is unlikely, however. Key members of parliament have already indicated that if the “leave” vote wins, they will push to have Britain remain within the single market. And that would be politically popular – the voters who want to leave don’t care about trade agreements, they just want Britain’s sovereignty affirmed (and for people who don’t look like them to go home).

And that resolution is not without precedent – countries like Norway, Iceland and Lichtenstein have exactly that sort of relationship, are exempt from many EU regulations, and don’t have to cooperate on justice or foreign affairs issues.

So all that said, if Britain votes to leave I believe we will see some minor panic, the British pound will devalue and capital will flee to the safety of US treasuries, driving down interest rates and strengthening the dollar. If that lasts for a long time, that’s bad for US exports as it makes our products and service more expensive everywhere else. That would have a negative impact on the TSP’s domestic stock funds (the C Fund and S Fund). But I don’t think the panic would have legs – if the vote goes that way the financial system will adjust relatively quickly to a new normal.

The TSP I Fund would likely take a fairly solid hit as a result of a Brexit vote, as UK stocks makes up 20% of its holdings. Any number I throw out here is just a guess, but I wouldn’t be surprised to see a short term decline of at least 10%.

But if I were betting, I would put money on Britain voting to remain within the EU. Change is scary and I think voters will decide it is too scary right now. That doesn’t mean the global economy will suddenly take off and take the markets with it, but more likely that we will continue petering along in our slow growth recovery.

I am maintaining my 15% allocation to the TSP I Fund. I believe the odds are that it will outperform over the mid-term, and it is a small enough amount that if things turn out worse than my forecast, it won’t be a huge blow.

This Month’s Economic Numbers:

In this section I will 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: The unemployment rate declined by 0.3 percentage point to 4.7 percent in May, and nonfarm payroll employment changed little (+38,000)I obtain this data from the Bureau of Labor Statistics.

The number of jobs created was significantly lower than forecasts called for. That isn’t great news, but I don’t attribute much importance to a number like this in any single month. If we see continued weakening over the next few months, that will be something for me to pay attention to.

TSP unemployment June 2016Purchasing 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 this month’s reading of 51.3 is also well above the 43.2 which indicates an expansion of the overall economy:

Manufacturing expanded in May as the PMI registered 51.3 percent, an increase of 0.5 percentage point from the April reading of 50.8 percent, indicating growth in manufacturing for the third consecutive month, following five consecutive months of contraction in manufacturing. 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 May PMI indicates growth for the 84th consecutive month in the overall economy, while indicating 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 May (50.3 percent) corresponds to a 2.2 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for May (51.3 percent) is annualized, it corresponds to a 2.6 percent increase in real GDP annually.”

And here’s a snapshot of the last 12 months – I like the way it is trending:

PMI last 12 months June 2016Yield spreads: The yield curve flattened slightly in May, which ever so slightly increases the probability of recession. 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 8.29 percent, up from April’s 7.33 percent and 7.45 percent in March. 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 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 12733 USD Billion in May from 12652.20 USD Billion in April of 2016.

TSPAG money supply May 2016Conclusion

All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am maintaining the bulk of my investments in the TSP C Fund, while maintaining my position in the I Fund. I also believe that the probability of the US economy entering a recession in the next year (which is the whole point of this exercise) is low.

Recommended Reading for TSP Investors
This month’s book is The WSJ Guide to the 50 Economic Indicators That Really Matter: From Big Macs to “Zombie Banks,” the Indicators Smart Investors Watch to Beat the Market (Wall Street Journal Guides). It is a very entertaining read and does a great job of explaining all those things you hear about on CNBC or read about in the financial section, but nobody ever explains. I obviously don’t believe that there are 50 indicators which really matter (I tend to look at four), but I learned a ton from this book and highly recommend it.

The Next Update

Unless something unexpected happens, I will send out my next update about this time next month. 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

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Mr. BeanI 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 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!

Sell in May and Go Away – the truth behind the adage

TSP allocation guide May 2016In late spring each year, I start getting emails and message board questions asking why I don’t sell my TSP stock funds and move to the TSP F (or G) Fund for the summer. After all, “everyone knows” that all the stockbrokers go to the Hamptons, volume goes way down, and the stock market loses ground during that period every year.

There are a number of variations on the adage, but they all revolve around selling near Memorial Day and buying back into the stock market after Labor Day. Calendar based strategies are always appealing, but how has this one actually played out?

From 1970 to 2017 (so let’s call that the modern stock market), the S&P 500 has been up 32 times during the summer months, and declined 15 times. So better than two years out of three the market is up during that dreaded period. I’m not saying that the market will be up during the summer in any given year, but the odds are that it will.

To be fair, stocks were up 5.8% during the up years, and down 8% during the down years, so that evens things out a bit in terms of total return. But on average the S&P 500 has gained 1% during each of those 47 summers. (Going back further, the S&P 500 averaged 2.2% from May to October from 1950 to 2017). And in 2017, the S&P 500 was up 7.4% from the beginning of May to the end of October.

But let’s stick with that 1% number. 1% doesn’t sound like very much money – that’s only a penny per dollar invested. It sounds like such a negligible sum that it might be worth sitting out the summer months just so you don’t have to worry about it.

math-plus-funAnd that brings us back to fun with math. What if I told you that in a very realistic scenario, 1% a year could turn into hundreds of thousands of dollars in your Thrift Savings Plan by the time you were ready to spend it?

To work those numbers, let’s go to our Investor.gov compound interest calculator at: https://www.investor.gov/tools/calculators/compound-interest-calculator

Once we get there we will start with $1 in current principal (to simulate being a brand new employee), $1000 monthly addition (which is probably a little high for a new employee and very low for a more experienced one), 30 years to grow (which reflects a nice long government career), an interest rate of 8% (which is fully 2% under the S&P 500’s average return during the period 1928-2016), and we will compound that 12 times per year. That gets our TSP balance to $1,490,370 after 30 years. Not bad.

Now just make one little change – turn the 8% into 9% to account for that 1% average difference between sitting out the summers and staying invested. That results in a Thrift Savings Plan balance of $1,830,758 – a difference of $430,388. And roughly 19% more than the guy who didn’t do the math.

And that is why my money doesn’t go on vacation during the summer.

thrift savings plan retirement