Current Thrift Savings Plan Allocation and Underlying Business Cycle Phase – October 2013

THIS IS AN ARCHIVE POST – THE CURRENT UPDATE CAN BE VIEWED HERE.

Updated 10/13/2013: My current Thrift Savings Plan allocation remains 100% in the TSP S Fund.

This month has been dominated by political rather than economic news. I wrote a special update post on the debt limit and government shutdown a few days ago, and my views remain the very much the same today. I believe the market (and our Thrift Savings Plan balances with it) will take a hit tomorrow when it opens after a weekend in which many observers expected to see more progress, but I do believe we will see Congress take action at the last minute to avoid damaging the economy enough to change the phase of the economic cycle we are in.

Based on all of the economic indicators which I describe in my How to Determine the Business Cycle’s Current Phase post, I believe that we remain in the recovery/expansion phase which started in Spring 2009, and so I remain 100% invested in the TSP S Fund.

As always, I will run through the indicator data I used and what it means to me in making decisions for my Thrift Savings Plan:

(1) employment numbers: This month I could not go to the Bureau of Labor Statistics for the September 2013 numbers because they are furloughed. Instead I took a look at various reports from other sources, including this Wall Street Journal analysis:

156,000: The numbers of jobs added in September, according to an amalgamation of several private sources of labor market data.

 

Absent the BLS report, other data, mostly from private sources, offer hints about last month’s job markets. The cumulative result: probably no surprise pop in payrolls or unexpected worsening in unemployment.

(2) money supply growth rate: I obtain this data from the Federal Reserve:

Money Supply M2 in the United States increased to 10815 USD Billion in September of 2013 from 10768 USD Billion in August of 2013.

That continued upward trend is what we are looking for:

United States Money Supply M2 - TSP Allocation Strategy Guide
(3) the stock market: the stock market (which I really consider to be a trailing indicator even though the Wall Street types like to think that the market predicts the economy) continued to trade sidewise last month. But that is fine – remember that we aren’t worried about short term swings and fluctuations in the stock market when we are investing in the Thrift Savings Plan. Take a look at the five year chart below to put the current choppiness into perspective:

TSP 5 year chart October 2013
(4) yield spreads: I continue to get my data for this section from the Cleveland Federal Reserve. The yield spread is huge, which indicates a very, very low probability of recession, and it continues to trend in the right direction:

Yield Curve graphic Oct 2013 TSP Allocation Guide Update

(5) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report (remember that any number above 50 indicates economic growth):

Economic activity in the manufacturing sector expanded in September for the fourth consecutive month, and the overall economy grew for the 52nd consecutive month, say the nation’s supply executives in the latest Manufacturing ISM Report On Business®. The PMI registered 56.2 percent, an increase of 0.5 percentage point from August’s reading of 55.7 percent. September’s PMI reading is the highest of the year, leading to an average PMI reading of 55.8 percent for the third quarter. The New Orders Index decreased in September by 2.7 percentage points to 60.5 percent, and the Production Index increased by 0.2 percentage point to 62.6 percent. The Employment Index registered 55.4 percent, an increase of 2.1 percentage points compared to August’s reading of 53.3 percent, which is the highest reading for the year.

So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Expansion Phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing.

For those of you who feel you need some diversification in setting your best TSP allocation and maintain a percentage in the “safer” funds, I would still caution you not to be invested in the TSP F Fund during this period of increasing interest rates. I go into great detail in my F Fund vs. G Fund post, but the nutshell is that as interest rates rise, the bonds held by the TSP F Fund will lose value and the TSP F Fund will do poorly for the foreseeable future (as it has the past several months). It will certainly have a few good positive months mixed in, but the long term trend will be grim.

And if any of your current Thrift Savings Plan allocation is in the TSP L Funds, remember between 6% and 9.25% of your savings are in the TSP F Fund which is almost certain to perform badly in the near term.

Unless something dramatic happens, I will update this post again around this time in the second week of November after all of the October data comes in. I send out notifications of these updates (or allocation changes) to the email list which you can subscribe to here: SUBSCRIBE

As always, if you find this site useful, it would mean a lot to me if you would share it with your friends and colleagues who are Thrift Savings Plan participants using the email and social sharing buttons below.

Shutdown and Debt Limit Update

10/08/2013

I have received a fair number emails about the shutdown and the debt ceiling over the past few weeks, and even a Message Board question (which made me very happy). Today Bill over at FedTrader announced that he was switching to 100% G Fund to and the trickle turned into a torrent (which shows how many common readers we have), so instead of waiting until I get around to putting the monthly update out, I feel like I should get something out explaining where I stand.

So first, a quick explanation of the difference between the investing styles which Bill and I practice. I tread cautiously here because I don’t feel comfortable characterizing what he does or don’t want it to seem like I am suggesting that mine is better or more valid. I like reading Bill’s stuff, sometimes I agree with him and sometimes I don’t, but it is good for me to see what other people people are thinking. I would describe Bill as mixing technical analysis with momentum investing. Which is all good. I am admittedly not a huge fan of technical analysis (probably just because I’m not clever enough to remember what the double tea cup means when Aquarius is ascending), but for my individual stock picks I am a momentum guy. Both of those are market timing strategies – trying to take cues from the stock market (and from media sentiment in the momentum strategy) to buy low and sell high.

In contrast, I try to gauge the economic cycle, which moves at a glacial pace compared to the stock market. As a result, I make a lot fewer moves in my Thrift Savings Plan than Bill does in his, and only react to things which I believe will change the phase of the economic cycle rather than discrete events such as the shutdown, natural disasters, or threats of military action which may change the direction of the market for a few days. You can find a much fuller explanation in my post on discrete events from a few months ago.

Which brings us to today. I am still 100% invested in the TSP S Fund, despite the political maelstrom in DC these days. The shutdown, even if it lasts a few weeks, will not be enough to really impact the economic cycle. A default on the nation’s debt (not raising the debt ceiling), on the other hand, could very well push us back into recession – but I don’t believe that will happen.

I thought we might see a dip as we came into October and I did seriously consider going to a 50% position in the G Fund and buying back in on that dip, particularly because I didn’t see much chance that I would miss out on a big move to the upside. But it wasn’t a sure thing, and that would have been a pretty dramatic departure from the very long term approach which I apply to my Thrift Savings Plan and advocate here.

As far as the debt ceiling goes, I believe that the politicians may well push it right up the wire but then they will raise it. Today it looks most likely they will wait until the bitter end, do a short term extension (probably until just before Christmas when nobody will be paying attention) and then will cut some deal, both declare victory, and move on to the next manufactured crisis. Whatever the specifics of the deal, I don’t believe that there are enough crazies on the Hill who believe that they could survive the economic catastrophe which would result for Congress to allow the US to go into default. If all else fails, Speaker Boehner will allow a vote to raise the ceiling temporarily which moderate Republicans and Democrats will support.

I believe it will be a very choppy next week or two in the Thrift Savings Plan, but I think the above assumptions are pretty well priced in and we will mostly just continue to trade sidewise as we have been. I doubt we will see more than about a 3% drop at worst, although I admit that is more gut than science. And when a continuing resolution is passed (and one will be) and  when the debt limit is raised (and it will be), we will see a rally which will more than make up for whatever we might lose between now and then.

So I’m staying the course with the TSP S Fund. That said, for folks who are nervous it would be perfectly fine in the long run for them to move some or all of their balance into the TSP G Fund until that happens so they can sleep more soundly.

-TS

Current Thrift Savings Plan Allocation and Underlying Business Cycle Phase – September 2013

This is an archive version of the current update. You can find the current update here.

Updated 09/12/2013: My current Thrift Savings Plan allocation remains 100% in the TSP S Fund.

Based on all of the economic indicators which I describe in my How to Determine the Business Cycle’s Current Phase post, I believe that we remain in the early (recovery) phase which started in Spring 2009, and so I remain 100% invested in the TSP S Fund.

As always, it really only took ten minutes today for me to pull the data which I feel like I need to make that Thrift Savings Plan allocation decision and I will run through that again below.

Before I do that, though, I would like to thank everyone who has shared the website with their friends and colleagues. We have seen some extraordinary growth since I put the first post online in mid-April and, while Google is sending a lot of traffic this way, I believe much of that is due to your passing our information on. The chart below shows our growth in daily visitors:

tspallocation.com growth chartIf you are finding value here, please do take a second to share this by liking us on Facebook, emailing this to some fellow Feds or service members, or through any of the other social sharing icons below.

I will run through where I get the indicator data I am using and what it means to me when I am making decisions for my Thrift Savings Plan:

(1) employment numbers: This month I went back to the Bureau of Labor Statistics for the August 2013 numbers:

Total nonfarm payroll employment increased by 169,000 in August, and the unemployment rate was little changed at 7.3 percent. Employment rose in retail trade and health care but declined in information.  Both the number of unemployed persons, at 11.3 million, and the unemployment rate, at 7.3 percent, changed little in August. The jobless rate is down from 8.1 percent a year ago.

And the unemployment rate trend continues to be exactly what we want to see:

unemployment rate chart through August 2013 - TSP Allocation Guide(2) money supply growth rate: I obtain this data from the Federal Reserve:

Money Supply M2 in the United States increased to 10770.8 USD Billion in August of 2013 from 10709.7 USD Billion in May of 2013.

This continued upward trend is what we are looking for:

United States Money Supply M2 - TSP Allocation Strategy Guide
(3) the stock market: the stock market (which I really consider to be a trailing indicator even though the Wall Street types like to think that the market predicts the economy) took a breather last month. But that is fine – remember that we aren’t worried about short term swings and fluctuations in the stock market. Take a look at the five year chart below to put last month’s blip into perspective:

S&P 5 Year Chart - TSP Allocation Guide
(4) yield spreads: I continue to get my data for this section from the Cleveland Federal Reserve. The yield spread is huge, which indicates a very, very low probability of recession, and it continues to trend in the right direction:

Yield Curve August 2013 - TSP Allocation GuideTo demonstrate the historic utility of the yield curve in predicting recessions (which is far and away the most important thing we are trying to do here), take a look at this graphic:

Recession Probability from Yield Curve - TSP Allocation Guide(5) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report (remember that any number above 50 indicates economic growth):

Economic activity in the manufacturing sector expanded in August for the third consecutive month, and the overall economy grew for the 51st consecutive month. The PMI™ registered 55.7 percent, an increase of 0.3 percentage point from July’s reading of 55.4 percent. August’s PMI™ reading, the highest of the year, indicates expansion in the manufacturing sector for the third consecutive month. The New Orders Index increased in August by 4.9 percentage points to 63.2 percent, and the Production Index decreased by 2.6 percentage points to 62.4 percent. The Employment Index registered 53.3 percent, a decrease of 1.1 percentage points compared to July’s reading of 54.4 percent. The Prices Index registered 54 percent, increasing 5 percentage points from July, indicating that overall raw materials prices increased when compared to last month. Comments from the panel range from slow to improving business conditions depending upon the industry.

So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Early/Recovery/Expansion Phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing.

With respect to the TSP I Fund, I mentioned last month that sentiment appeared to be turning on Europe and that I would take a closer look. I did, and I am not convinced. While I believe that we may see some good months mixed in going forward for the TSP I Fund, I believe that there is a significant downside risk as well. I do believe that Europe is exiting their recession, but so slowly and chaotically that we have not seen the sustained uptrend which we have seen in the US over the past four years. And for all of Japan’s recent successes, Abenomonics is still a work in progress. If you have not read our deep dive into the the TSP I Fund yet, you can find it here: The Best International Fund of the 1970s.

For those of you who feel that you need some diversification in setting your best TSP allocation and maintain a percentage in the “safer” funds, I would caution you not to be invested in the TSP F Fund during this period of increasing interest rates. I go into great detail in my F Fund vs. G Fund post, but the nutshell is that as interest rates rise, the bonds held by the Thrift Savings Plan will lose value and the TSP F Fund will do poorly for the foreseeable future (as it has the past several months). It will certainly have a few good positive months mixed in, but the long term trend will be grim.

And if any of your current Thrift Savings Plan allocation is in the TSP L Funds, remember between 6% and 9.25% of your savings are in the TSP F Fund which is almost certain to perform badly inthe near term.

Unless something dramatic happens, I will update this post again around this time in the second week of October after all of the September data comes in. I send out notifications of these updates (or allocation changes) to the email list which you can subscribe to here: SUBSCRIBE

As always, if you find this site useful, it would mean a lot to me if you would share it with your friends and colleagues who participate in the Thrift Savings Plan using the email and/or social sharing buttons below.

Advanced Bond Fund Investing with the Thrift Savings Plan

advanced bond fund investing graphicThere is an advanced TSP F Fund strategy for those of you whose retirement investment accounts extend beyond the Thrift Savings Plan. Note that when you look at the constituent parts of the Barclays Aggregate Bond Index tracked by the TSP F Fund, the index contains US Treasury securities. Because the securities issued to the TSP G Fund are preferable to those in the F Fund, some investors take a more complicated approach at times when they would otherwise invest in the F Fund. By dividing the total funds they have dedicated to bonds between the G Fund and two non-Treasury bond funds which they hold in a non-TSP retirement account, they can obtain a comparable yield with lower volatility and no risk of loss for the government portion.

The Thrift Savings Plan’s F Fund is composed of approximately 45% US Government Treasuries and other US agency bonds, 22% investment grade corporate bonds (BBB and higher ratings),  28% Mortgage Backed Securities (MBS) passthroughs, and another 5% in miscellaneous foreign treasury bonds traded in the US. So if I was currently 100% invested in the TSP F Fund with a $100,000 balance and wanted to execute this strategy, I would first change my TSP contribution allocation and conduct an interfund transfer to 100% TSP G Fund. I would next turn to my other retirement accounts (IRA, Roth IRA, or 401K), where, assuming I had sufficient funds, I would invest $44,000 in Vanguard’s Intermediate-Term Corporate Bond ETF (ticker symbol: VCIT), and $56,000 in Vanguard’s Mortgage-Backed Securities ETF (VMBS) or, if you have a strong preference for mutual funds over ETFs, perhaps Vanguard’s GNMA fund (ticker symbol: VFIIX).

There is nothing magic about these percentages, so while I would try to roughly match the TSP F Fund’s investments, it would be fine if they didn’t line up exactly. The example would be more complicated if we were in a rare situation where our current TSP allocation also included the TSP C Fund or the TSP I Fund, but that would simply require us to reallocate the 50% we were pulling out of the bond portion of our allocation within the Thrift Savings Plan, or perhaps shift a higher percentage of our stock fund allocation to the outside retirement accounts. And if you have a 401K plan, of course you are limited to whatever funds are offered in your particular plan and will have to do some research to determine what gives you the appropriate mix of intermediate-term corporate bonds and mortgage backed securities.

All that said, as of this writing (September 2013), I would not be putting any money into the TSP F Fund or any bond fund. I believe that the long term trend for interest rates is up, particularly once the Fed starts tapering QE, and the TSP F Fund will do very poorly as that happens. The TSP F Fund will certainly have a few good months mixed in there as rates fluctuate, but I wouldn’t want to be guessing which months those might be.

I would love to hear your thoughts or questions in the comments below or on the Message Board.

Return to F Fund vs. G Fund in TSP Allocation

Current Thrift Savings Plan Allocation and Underlying Business Cycle Phase (August 2013)

This is an archive page. Click here for Current Thrift Savings Plan allocation update.

Updated 08/12/2013: My current Thrift Savings Plan allocation remains 100% in the TSP S Fund.

Based on all of the economic indicators which I describe in my How to Determine the Business Cycle’s Current Phase post, I believe that we remain in the early (recovery) phase which started in Spring 2009, and so I remain 100% invested in the TSP S Fund. See my note below about the momentum shift we are seeing in the TSP I Fund.

Once again, although I personally spend a fair amount of time reading business and economic news each day, it really only took ten minutes today for me to pull the data which I feel like I need to make that Thrift Savings Plan allocation decision.

I will run through where I get the indicator data I am using and what it means to me:

(1) employment numbers: This month I just went straight to the Bureau of Labor Statistics press release with the July 2013 numbers:

Total nonfarm payroll employment increased by 162,000 in July, and the unemployment rate edged down to 7.4 percent, the U.S. Bureau of Labor Statistics reported today. Employment rose in retail trade, food services and drinking places, financial activities, and wholesale trade.

This is the trend which we like to see:

unemployment rate chart - TSPallocation.com

(2) money supply growth rate: The Federal Reserve has not yet released the July numbers, but I don’t have any reason to believe that the growth trend will not continue. From last month:

Money Supply M2 in the United States increased to 10598.1 USD Billion in June of 2013 from 10552.60 USD Billion in May of 2013.

This continued upward trend is what we are looking for:

United States Money Supply M2 - TSP Allocation Strategy Guide
(3) the stock market: Virtually all sectors of the market ended July higher than they started and it is so clear that the market’s upward trend continued in July it is not even worth bothering to bore into the details.

(4) yield spreads: I continue to get my data for this section from the Cleveland Federal Reserve. The yield spread is huge, which indicates a very, very low probability of recession, and it continues to trend in the right direction:

yield curve August 2013 TSPallocation.com

(5) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report (remember that any number above 50 indicates economic growth):

Economic activity in the manufacturing sector expanded in July for the second consecutive month, and the overall economy grew for the 50th consecutive month. The PMI registered 55.4 percent, an increase of 4.5 percentage points from June’s reading of 50.9 percent. June’s PMI reading, the highest of the year, indicates expansion in the manufacturing sector for the second consecutive month. The New Orders Index increased in July by 6.4 percentage points to 58.3 percent, and the Production Index increased by 11.6 percentage points to 65 percent. The Employment Index registered 54.4 percent, an increase of 5.7 percentage points compared to June’s reading of 48.7 percent. The Prices Index registered 49 percent, decreasing 3.5 percentage points from June, indicating that overall raw materials prices decreased from last month. Comments from the panel generally indicate stable demand and slowly improving business conditions.

So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Early/Recovery/Expansion Phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing.

With respect to the TSP I Fund, if this was my Vegas money instead of my retirement account, I would be rolling some of my Thrift Savings Plan allocation into the TSP I Fund because I think that it is likely to outperform all of the other TSP Funds over the next few months. I believe that that positive media and investor sentiment on the European recovery has created enough momentum to make that happen. But this is my retirement account, and I don’t want to be buying single ply toilet paper when I’m in my 80s, so I will remain conservative at this point and stick with the TSP S Fund. While I think that we are going to see at least a temporary move in the TSP I Fund, I haven’t devoted the time to really understanding the underlying economies so I am not comfortable enough risk any of my Thrift Savings Planbalance, particularly not when the TSP S Fund is performing at the fantastic levels that it is (up 24% over the last 12 months), and I believe that there is a significant downside risk to the TSP I Fund as well. I will take a closer look at both Europe and Japan before my September update, and may well decide to make a shift then. If you have not read my explanation of the TSP I Fund yet, you can find it here: The Best International Fund of the 1970s.

For those of you who feel that you need some diversification in setting your best TSP allocation and maintain a percentage in the “safer” funds, I would caution you not to be invested in the TSP F Fund during this period of increasing interest rates. I go into great detail in my F Fund vs. G Fund post, but the nutshell is that as interest rates rise, the bonds held by the TSP F Fund will lose value and the TSP F Fund will do poorly for the foreseeable future (as it has the past several months). And if any of your current Thrift Savings Plan allocation is in the TSP L Funds, remember between 6% and 9.25% of your savings are in the TSP F Fund which is almost certain to perform badly in at least the near term.

As always, if you find this site useful, it would mean a lot to me if you would share it with your friends and colleagues who participate in the Thrift Savings Plan by using the email and/or social sharing buttons below.

The Role of the TSP I Fund in Thrift Savings Plan Allocation Strategy

When you see stories about extraordinary growth in China, India and other burgeoning economic superpowers, you no doubt assume that you are participating in that growth if you are invested in the Thrift Savings Plan’s I Fund. Unfortunately, that is not the case because the TSP I Fund is badly flawed as the only option which government employees and service members have for international exposure in their Thrift Savings Plan. There are still some circumstances in which the TSP I Fund will fit into your TSP strategy, but it is much more complicated than picking a percentage to allocate so you have “some international exposure.”

Pan Am - TSP I FundThe TSP I Fund (sometimes referred to as the TSP International Fund) tracks the MSCI EAFE Index which was created in 1969 to track the largest stocks in Europe, Australasia, and the Far East (EAFE). Back in 1969 when international investing was just becoming a reality, the dominant international markets were in Europe and Japan. Unfortunately for Thrift Savings Plan investors, the index hasn’t changed since it was created, and European markets still comprise about 70% of the index followed by Japanese markets at 22%, for a total of 92% of the entire index. Those are both still big markets, but they don’t have the growth of China, India, Brazil and the rest of the engines of global growth in the developing world which are completely excluded from the TSP I Fund. And to make things worse, the index tracked by the TSP I Fund includes such basket cases as Italy, Portugal, and Spain.

TSP I Fund_-_country weightsThe TSP I Fund has a place in my TSP allocation strategy, but that determination is based on a different business cycle than the US business cycle which we use to determine our other Thrift Savings Plan allocations. In fact, it relies on a combination of multiple business cycles: the major European countries and Japanese cycles. A lot of TSP talk superficially revolves around the need to have international exposure, but it very seldom goes any deeper to examine what international exposure the TSP I Fund actually provides.

The MSCI EAFE Index is weighted by market capitalization, which means that stocks are purchased for the TSP I Fund’s portfolio in proportion to how large the companies are. That means that the index is skewed strongly towards a few very large companies – in fact 15% of all the shares held in the TSP I Fund are from just ten companies. Which means smaller cap companies are almost completely excluded, and the TSP I Fund will perform best when both Europe and Japan are in the Mid (Growth) Phase of the business cycle. For the purpose of determining the best TSP fund combination at any given time, think of the TSP I Fund as a C Fund for Japan, the UK, Germany, France, and Switzerland.

The TSP I Fund as a Buy-and-Hold Candidate

The MSCI EAFE Index was created to track developed markets under the theory that they are more mature and stable than the newer markets, but Vanguard rates its Developed Markets Index Fund (a mutual fund which is virtually indistinguishable from the TSP I Fund) as “High Risk”. Take a look at the volatility it has displayed since 2001:

TSP I Fund performance since 2001

Anyone who thinks that the TSP I Fund is a buy-and-hold-forever candidate should take a look at the following chart – if you had put your money to work in the I Fund in 2008 you would still be down about 22% for your trouble (as of July 2013 when this post was written).

I Fund
I Fund

And comparing the buy-and-hold-forever performance of the TSP I Fund to the other funds (data from 8/31/1990 to 07/17/2015), take a look at the hypothetical performance of $10,000 invested in each Thrift Savings Plan fund continuously for the past 25 years:

  • TSP S Fund: $143,930
  • TSP C Fund: $111, 430
  • TSP F Fund: $  47,770
  • TSP I Fund:  $  42,710
  • TSP G Fund: $  32,850

Mutual Fund and ETF Equivalents to the TSP I Fund

For anyone interested in investing in non-TSP equivalents to the TSP I FUND, Vanguard has its low expense Developed Markets Index mutual fund (ticker symbol VDVIX) and an ETF (exchange traded fund) which track the MSCI EAFE Index (ticker symbol VEA), both of which are excellent proxies for the TSP I Fund. iShares also has an EAFE ETF as well (ticker symbol EFA), but when last I checked its expenses were triple that of the Vanguard ETF so there would be no reason to purchase that product unless that was the only option in a 401K.

Recommended Reading for International Investing

If you want to read more about international investing specifically, the only book on my shelf or Kindle which I can think of worth recommending is Own the Globe: How Smart Investors Create Global Portfolios, by Aaron Anderson. If you know of another worth taking a look at, please let us know by sharing in the comments below.

If you found this post useful, or even just interesting, please help me by sharing with your friends and colleagues who participate in the Thrift Savings Plan through an email, tweeting it, or liking it through the social media buttons below. Thanks very much!

Current Thrift Savings Plan Allocation and Underlying Business Cycle Phase (July 2013)

This is an archive page. Click here for current Thrift Savings Plan allocation post.

Updated 07/12/2013: My current Thrift Savings Plan allocation remains 100% in the TSP S Fund.

Based on all of the economic indicators which I describe in my How to Determine the Business Cycle’s Current Phase post, I believe that we remain in an early (recovery) phase which started in Spring 2009, and so I remain 100% invested in the TSP S Fund.

Ten minutes. That is all that it took for me to pull the data which I feel like I need to make that determination, and I only need to do that once a month. (Investing is a pretty serious hobby of mine, so of course I spend more time than that, but it really isn’t necessary – particularly when all of the indicators are pointing in the same direction).

I thought that it might be instructive to run through where I get the indicator data I am using and what it means to me:

(1) employment numbers: I looked at both the Econoday and MarketWatch calendars. Of note, monthly jobless claims fell and:

The June employment situation largely came in better than expectations-at least on the payroll survey portion. Total payroll jobs in June increased 195,000 after rising a revised 195,000 in May (originally up 175,000). The consensus forecast was for a 161,000 gain for June. The net revisions for April and May were up 70,000. The unemployment rate held steady at 7.6 percent.

(2) money supply growth rate: I looked at numbers released by the Federal Reserve which is in a table which I just couldn’t make look right in this post, but the nutshell is that the growth trend continued and:

Money Supply M2 in the United States increased to 10598.1 USD Billion in June of 2013 from 10552.60 USD Billion in May of 2013.

This continued upward trend is what we are looking for:

United States Money Supply M2 - TSP Allocation Strategy Guide

(3) the stock market: Both the Dow and the S&P 500 set new all time highs today. I probably don’t need to see anything more than that to convince myself that the market’s upward trend is continuing.

(4) yield spreads: to get my data for this section I Googled “current yield spread” which led me to a recent release from the Cleveland Federal Reserve. The yield spread is huge, which indicates a very low probability of recession, and it is trending in the right direction:

June
May
April
3-month Treasury bill rate (percent) 0.05 0.04 0.06
10-year Treasury bond rate (percent) 2.20 1.93 1.73
Yield curve slope (basis points) 215 189 167
Prediction for GDP growth (percent) 0.4 0.3 0.5
Probability of recession in 1 year (percent) 4.4 6.1 8.1
(5) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report:
Economic activity in the manufacturing sector expanded in June following one month of contraction, and the overall economy grew for the 49th consecutive month. […] The PMI™ registered 50.9 percent, an increase of 1.9 percentage points from May’s reading of 49 percent, indicating expansion in the manufacturing sector for the fifth time in the first six months of 2013.

So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Early/Recovery/Expansion Phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing.

For those of you who feel that you need some diversification in setting your best TSP allocation and maintain a percentage in the “safer” funds, I would caution you not to be invested in the TSP F Fund during this period of increasing interest rates. I go into great detail in my F Fund vs. G Fund post, but the nutshell is that as interest rates rise, the bonds held by the TSP F Fund will lose value and the TSP F Fund will do poorly for the foreseeable future (as it has the past several months). And if any of your current Thrift Savings Plan allocation is in the TSP L Funds, remember between 6% and 9.25% of your savings are in the TSP F Fund which is almost certain to perform badly in at least the near term.

As always, if you find this site useful, it would mean a lot to me if you would share it with your friends and colleagues who are Thrift Savings Plan participants using the email and/or social sharing buttons below.

China, the Fed and Meaningless Market Volatility

I have received a large number of emails over the past few days about the stock market’s recent drop. My Thrift Savings Plan investing strategy is such that I ignore minor blips such as these, except to marvel at the how clever Wall Street is in encouraging meaningless volatility which, of course, is to their benefit as they trade ahead of the public both on the way down, and on the inevitable way back up. I do not try to trade these events, because by the time you recognize that one is occurring and get out of the market, it will have turned and you will have locked in your losses and missed the recovery.

DOW biggest one-day drop - www.tspallocation.com tsp allocation

While I will not typically bother discussing a minor event such as this, I thought it was worth explaining how I view these episodes and why they play no role at all in how I determine my Thrift Savings Plan allocation. When I get some more time I will expand this post to cover what finance types call “discrete events”, which, no matter how horrific and newsworthy, almost never have anything more than a very short term impact on the market.

The media created a frenzy last week with dramatic screen graphics screaming: “The DOW’s Largest Drop”, “Liquidity Crisis in China”, and “Fed Action Spurs Market Crash”. The media is trying to sell ad time, so they spin stories to try to get you to watch or read, even if the facts behind the story in no way lead to the explosive conclusion which they try to draw. Let’s look at each of those stories separately:

You had to go to the fine print to see that the calamity they were referring to was limited to the DOW’s largest decline in 2013. This has been a very good year for the market, so it was a fairly unremarkable drop and it stood out only because the DOW (and the broader market) have done so very well this year. I predict that there will be several more “biggest drop” stories this year, none of which will have any long term impact on the market or my Thrift Savings Plan.

There were several front page stories in the press about interest rates rising in China and the difficulty that businesses were having getting loans, with talking heads pushing the notion that this was somehow going to result in China’s crash and a global economic meltdown. While China no longer has a command economy, interest rates and money supply remain strictly controlled by the central government. When Beijing wants interest rates to go down, they will go back down in very short order. Another non-story for Thrift Savings Plan investors.

Finally, the stories about the Federal Reserve starting to merely discuss the tapering off of Quantitative Easing hid great economic news under several layers of speculation about what impact that might have on the markets. Quantitative Easing means that the Federal Reserve is currently printing and pumping $85 billion per month into the US bond market. The Fed is buying agency-backed mortgage securities (Ginnie Mae, Fannie Mae or Freddie Mac) and Treasury securities to artificially hold interest rates low in an effort to stimulate growth. The reason that they are going to start tapering these purchases off is because the economy is doing well and no longer needs that crutch. In a release about the Federal Reserve Bank’s Open Market Committee meeting, officials predicted three percent GDP growth in the U.S. economy in 2014, low inflation, and a reduction of the unemployment level to six percent by the end of 2015. That is great news, and shows that the US economy is still solidly in recovery for my purposes in determining the best TSP allocation.

F Fund vs G Fund in TSP Allocation

Many TSP investors mistakenly believe the TSP F Fund and TSP G Fund are nearly interchangeable bond funds, with the only difference being that the TSP F Fund offers a slightly higher rate of return in exchange for some undefined but minimal risk when compared to the TSP G Fund, which provides a slightly lower return but is backed by the US Government. In fact, the two funds are not at all similar and are appropriate investments in different phases of the economic cycle.

I will go into a great deal of detail below, but here is the nutshell:

The TSP G Fund

The TSP G Fund is for all purposes what we call a cash investment. It is the same as a bank account or a certificate of deposit (CD). You cannot lose money when you are invested in the TSP G Fund and there is very little fluctuation in the rate of return which you will receive. While it does not have a high rate of return (particularly in this era of artificially depressed interest rates), it does provide a higher rate than any similar investment in the “cash investment” category. Because the only income generated by the TSP G Fund comes from interest earned on the special securities which it holds (the value of the securities held in the TSP G Fund cannot be traded and therefore do not change), it correlates exactly with interest rates. When those go up, the income generated by the TSP G Fund goes up, and when interest rates go down, the G Fund’s returns follow.

The TSP F Fund

The TSP F Fund is a bond index tracking fund. This means the TSP invests in exactly the basket of bonds and other securities which that index tracks. The bonds in the TSP F Fund generate income through the interest which is paid on these bonds, but the bonds held in the fund also go up and down in value as interest rates change which results in a gain or loss on the value of the underlying bonds. As a result, when interest rates go up or down, the TSP F Fund moves in the opposite direction (has a negative correlation). When interest rates go up, the value of the TSP F Fund goes down, and when interest rates fall, the value of the TSP F Fund goes up. The TSP F Fund also sees capital losses when bond issuers default and fail to make payments to the bond holders.

The role of the F Fund and G Fund in TSP allocation investment strategy

For the purposes of the economic cycle investment strategy which we follow, the TSP F Fund is used only during the recession phase of the cycle. As the economy slows and contracts, the Federal Reserve lowers interest rates in an effort to stimulate growth. This results in an increase in value (capital appreciation) for the bonds held by the TSP F Fund. This capital appreciation added to the interest income which the bonds generate will significantly outpace the returns of the TSP G Fund during these periods. As interest rates flatten out and prepare to rise, if I am still looking for a safe haven from the stock funds I will switch my allocation to the TSP G Fund. Note that when interest rates are flat, the TSP F Fund will outperform the TSP G Fund slightly, but typically by less than one percent which I am willing to forgo for the absolute certainty that I will not lose money if interest rates spike up.

TSP F Fund and G Fund Performance Comparison

I am going to go into some detail of the TSP F Fund and G Fund’s performance histories here to demonstrate how their performance correlates with what I have described above. Please remember that my point is not to show that one is better than the other overall. These funds are each the best choice for allocation during certain phases of the business cycle, and are each the worst possible choice during others.

When we look at interest sensitive TSP fund (the F Fund and G Fund) returns, you have to bear in mind that US interest rates have been trending consistently lower since the creation of the Thrift Savings Plan which results in returns skewed towards the TSP F Fund. At this point, interest rates have nowhere to go but up, and as a result many experts believe that bond funds like the TSP F Fund will do relatively poorly over the next decade or more.

interest rates chart TSP f fund vs TSP g fund government tsp allocation

The first Thrift Savings Plan funds were created in 1987 and 1988. To create a larger data set, I have combined what the returns would have been for the ten years prior to creation based on the indexes or securities which the various Funds track with the TSP returns so we can look at 1979 through the end of 2012. (If you want to look at the table which includes that pre-inception data, you can do that here: Extended TSP Fund Performance Table).

The picture (or chart) below, in this case, probably really is worth a thousand words. Note the rapid rise in interest rates in 1979 and 1980 corresponds with 7.2% and 8.5% advantages to the TSP G Fund, while the plummeting rates in 1982 saw the simulated TSP F Fund returning a whopping 31%. While less dramatic, the following years showed the same pattern repeat every time interest rates moved in one direction or the other, with the TSP F Fund actually having negative returns in 1994 (-2.96%) and 1999 (-0.85%).

 

 TSP F Fund vs TSP G Fund Performance Chart - www.TSPallocation.com

The TSP G Fund in Detail

The TSP G Fund’s investment objective is to produce a consistent rate of return which is higher than inflation while avoiding default risk and market price fluctuations. The TSP G Fund “invests” exclusively in a very short-term U.S. Treasury security which is specially issued only to the TSP. This security provides interest rates similar to those of long-term Government securities, but without risk of loss of value and the ability to trade on a daily basis. The earnings consist entirely of interest income on the security.

Put simply, using the TSP G Fund, you can earn roughly the same interest rate as someone who is locked into an investment in Treasury bonds for seven to ten years, while you are tied to it only for a day.

If you want to invest in something similar to the TSP G Fund outside your Thrift Savings Plan, you can’t. It is a one-of-a-kind security issued only to federal employees through the TSP.

The TSP F Fund in Detail

The TSP F Fund’s investment objective is to match the performance of the Barclays Capital U.S. Aggregate Bond Index, a broad index representing the U.S. bond market which includes U.S. Government, mortgage-backed, corporate, and foreign government sectors of the U.S. bond market. The TSP F Fund’s earnings consist of interest income on the bonds and gains (or losses) in the value of the securities.

Many investors do not understand what causes the value of bonds to go up and down and the dramatic impact a small change in interest rates can have on the value of a bond (or bond fund such as the TSP F Fund). Let’s take a simple example. Let’s say the TSP F Fund is holding a bond paying 4% interest and that bond is selling for $100. Now let’s say that interest rates have risen to 6%. That means that someone else can buy a new bond paying 6% for $100. Because yours is only paying 4%, that means the value of your bond will fall to $66.6667 in order to compete with the 6% bond.

A small rise in interest rates yields a huge drop in the value of bonds. You are getting $4 per year in yield, so In this case the drop in value is the equivalent to the interest you would earn in 8.5 years.

The same thing happens in reverse when interest rates fall. That 4% bond will be worth considerably more if interest rates drop to 2%.

The only time this doesn’t impact you is when you hold your bonds to maturity. That’s when you get your full $100 back. But the index which the TSP F Fund tracks doesn’t hold bonds to maturity – it uses an indexing approach to investing, which means that it is a passively managed fund which remains invested according to its investment strategy without regard for conditions in the bond market or the economy. The TSP F Fund is constantly buying and selling bonds so that it holds a certain percentage of each type of bond in the market.

If you want to invest in a mutual fund or exchange traded fund (ETF) similar to the TSP F fund outside your government TSP, it is most similar to the Vanguard Total Bond Market Index mutual fund (ticker symbol: VBMFX), Vanguard’s matching ETF (ticker symbol: BND), or the IShares Lehman Bond Index ETF (ticker symbol: AGG).

Advanced TSP F Fund Investing

For those of you whose retirement investment accounts extend beyond the Thrift Savings Plan, I have written another post on an advanced strategy which can be employed when the TSP F Fund is indicated for allocation which you can find here: Advanced TSP F Fund Investing Strategy

Thanks for reading. As always, I am eager to hear your thoughts and questions on this subject below or on the Message Board. And if you found this worth reading, please help us out by sharing with your friends and colleagues with the sharing or email buttons below.

How to Determine the Business Cycle’s Current Phase

The last post laid out the basic idea – all you have to do is change your Thrift Savings Plan fund allocation at each of the change points in the business cycle in order to maximize your return. There are hundreds of economists studying the business or economic cycle every day, so we must know where we are at any given time, right? And then all we have to do is invest in our Thrift Savings Plan based on where the authorities tell us we are, right?

As it turns out, it is not as simple as that. The strength of what we are doing is that we know what is coming next. The hard part is figuring out when we are at that turning point, and distinguishing a blip from a full blown recession.

The way we try to do that is by looking at a combination of economic indicators. Any one of which, or even any aggregation of indicators, can point us in the wrong direction, so we look at a wide variety and we look at three types of indicators – leading (which attempt to forecast the future), coincident (which measure where we are right now), and trailing (which tells us where we were).

I typically focus on:

(1) employment numbers: no indicator has more closely tracked the business cycle than labor force participation rates (which is the ratio between employed workers and all people in that age range), and the unemployment rate (which is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force). To make it very simple, as long as the unemployment rate is declining, that indicates to me that we are in the early (recovery) phase. When it flattens out, we are usually in the mid phase. As unemployment starts to increase (even a little), we are generally well into the late phase. And when unemployment increases dramatically, we are in recession. The following chart demonstrates the extraordinary correlation between initial jobless claims and the S&P 500 (TSP C Fund):

unemployment claims and TSP C fund chart - TSP Allocation Guide(2) money supply growth rate: this is an index of deposits at commercial banks and other institutions which accept deposits and is called M2. The growth rate corresponds well with the growth rate of GDP, and is generally available more quickly than GDP so it is a more timely indicator

(3) the stock market: the market generally anticipates movements in the economy – in recessions profits and earnings are down so stock prices should fall as soon as a recession is anticipated by the market. Every post-World War II downturn in the economy has been at least matched, if not anticipated, by the stock market. The problem is that there have been several downturns in the stock market which didn’t turn into recessions (the October 1987 crash, for example, which was followed by several years of continued growth). There is a joke among economists that the stock market has correctly predicted twelve of the last eight recessions.

(4) yield spreads: the difference between yields on long- and short-term government bonds) and the difference between yields on high- and low-grade bonds. Both of these recession probability using the yield curve spread - tsp allocation guidehave been useful in predicting downturns in the economy historically, but actions taken by the Federal Reserve to artificially hold interest rates low for extended periods of time (as it is currently doing) can throw the predictive value of these spreads into doubt.

The Federal Reserve Bank of New York published an article which explains this much better than I ever can: The Yield Curve as a Predictor of U.S. Recessions.

The following graphic nicely demonstrates the historical utility of the yield curve in predicting recessions. Note how the sharp upward spikes in the yield curve were predictably followed by recessionary periods.

Recession Probability from Yield Curve - TSP Allocation Guide

(5) Purchasing Managers’ Index (PMI): monthly surveys of private sector companies which measure both sentiment and hard numbers. The numbers generated by the indexes are important to me, but perhaps more important for projecting are the trends indicated by comparing the current numbers to those from past months. These numbers come from the Institute for Supply Management.

I track upcoming releases of economic data and detailed results through the Econoday Calendar. For a quicker snapshot I go to MarketWatch’s Economic Calendar.

Continue on to my most recent update to see where I believe we are in the business cycle right now and my current Thrift Savings Plan allocation:

Current Business Cycle Phase and Thrift Savings Plan Allocation