THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.
The Bull Market turns Six
March 9th was the sixth birthday of the current Bull Market. The Thrift Savings Plan S Fund is up 200% during this run. The other TSP funds have all trailed the S Fund, with the TSP C Fund up 150%, the I Fund up 112%, the F Fund up 28%, and the G Fund up 9.86%.
Periods of growth like this are the key to building a significant retirement nest egg. It is largely because of the dramatic gains during this period that my Thrift Savings Plan balance is rapidly approaching the million dollar mark, and my non-TSP investing balances are not far behind.
Stunningly, however, nearly one-third of all funds invested in the Thrift Savings Plan are held in the TSP G Fund, which is astonishing when you look at the relative returns above. Plug in any numbers you like, but for anyone with even an average balance the difference would be hundreds of thousands of dollars in missed returns during that period.
The Fed and Interest Rates
The market (and your Thrift Savings Plan balance) hasn’t gone straight up during that time and, as I’m sure you have noticed, volatility returned with a vengeance over the past week. The big story has been the possibility of the Federal Reserve raising interest rates sooner rather than later. The financial media will use this meme to explain pretty much every stock market drop until rates actually go up, but will never get around to explaining why the market goes up on the alternate days.
So why did the market drop so much a week ago? The short version: the stock market is exactly wrong about half the time in the short term.
The slightly longer version (and I promise it isn’t very long and will wrap up with some good news for you at the end): the February employment numbers came in at 296,000 jobs created, which caps an extraordinary run of similarly good numbers, and resulted in the unemployment rate falling to 5.5%. That is the upper end of the 5.2 – 5.5% range which is targeted as “full employment” by the Fed.
The fear which drove last Friday’s selling is that this great news (which shows that the US economy is continuing to strengthen) will result in the Fed starting to very slowly increase interest rates this summer instead of this fall. And that those higher interest rates will eliminate the cheap money which companies have been using to fund their operations (and to fund buybacks and dividends), and higher bond yields will pull money away from the stock market as everyone races off to buy bonds
A couple of points on this:
First, I am not at all convinced that the Fed will start to raise rates in May or June, or even anytime in 2015 for that matter. The Fed’s mandates are to maximize employment, keep prices stable, and maintain moderate long-term interest rates. Anything less than 5.2% unemployment could theoretically cause rampant inflation (which would be in conflict with that second mandate), so typically the idea is that the Fed would start to raise rates to keep that from happening. But the Fed also has an inflation target of 2%, and has been equally focused on pushing inflation up. Letting the unemployment rate continue to drop might be exactly what they need to do to push towards that target.
But they might raise rates this summer, and it would be next to meaningless in real impact over the medium and long term in our Thrift Savings Plan. The rate increases over the next year or two will be very small and won’t make any real difference in how much money companies will borrow, so it will have close to zero impact on corporate earnings, share buybacks and dividends. And I don’t really think everyone is going to sell all of their Apple stock and race off to buy ten year treasuries because they are paying 0.25% more than they were a few months ago
Interest rates are going to go up. It doesn’t make a bit of difference to long term investors whether that happens tomorrow or a year from now. It matters a great deal to CNBC and Marketwatch.com, because they can spin the specter of interest rate hikes into a scary story, and scary stories attract eyeballs for their advertising. Remember how we went through this for two years every time the Fed hinted that Qualitative Easing was going to end, and how the market kept powering up during that period?
Market performance before previous rate hikes (the good news I promised is in here)
The market is going to be volatile over the months leading up to a hike in interest rates because the day traders move the market temporarily on every bit of news. But if history is a guide the market will perform very well overall during that period.
The Fed has tightened monetary policy (which is another way of saying “raised interest rates”) six times since 1980. In the nine months prior to the first rate increase, the S&P 500 has gained an average of 23% (and 8.5% on average during the six months prior to the hike). So whether the Fed acts in June or September, we are in what has historically been a good period for the Thrift Savings Plan stock funds.
Those strong performances have not come without some angst for investors, however, as in each of the six periods described above the market has suffered a relatively significant setback at some point in the six months prior to the first rate hike. Most of those corrections have been in the 5-10% range. And we are well overdue for a 10% correction – we have gone 41 months without one, well in excess of the 18 months on average those occur. So we’ve got that to look forward to…
The market does well during this phase because the Fed is trying to balance a surging US economy at an optimal level of growth, employment, and inflation. If unemployment falls too low, the cost of labor increases as employers raise wages to compete for a limited supply of workers. Wages go up, which is good for the workers, but then so do prices because companies pass those wage increases along to their customers. If the US had a closed economy, it wouldn’t matter if wages and prices raced skyward together because everyone would be making enough to buy the more expensive goods and services. But we exist in a global economy, and if US wages and prices go up, while those remain lower in other countries, that puts the US at a competitive disadvantage. Our goods and services become too expensive, US companies’ sales decrease, they start laying people off, and we cycle into recession.
Current Thrift Savings Plan Allocation:
My current TSP allocation remains 100% in the TSP S Fund (this reflects both my contribution allocation as well as where my existing balances are invested).
Thrift Savings Plan Fund Performance Year to Date:
• TSP C Fund: 0.22%
• TSP S Fund: 3.71%
• TSP I Fund: 3.45%
• TSP F Fund: 0.53%
• TSP G Fund: 0.36%
February Economic Numbers:
I am going to dispense with most of the charts and discussion about the economic indicator numbers this month because – basketball. And also because there isn’t much to say – things are continuing to move in the right direction and I’m satisfied that we understand which phase of the business cycle we are in and the risk of recession is extremely low.
Employment numbers: the February jobs numbers were very strong, total nonfarm payroll employment increased by 295,000 in February, and the unemployment rate edged down to 5.5 percent.
Purchasing Managers’ Index (PMI): as usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates economic growth, and this month’s reading of 52.9 is within the range of what we are looking for, but it is worth noting it is the lowest number we have seen in more than a year
Yield spreads: The yield curve steepened in February, indicating stronger growth and a lower risk of recession. I obtain my data for this section from the Cleveland Federal Reserve.
Money supply growth rate: Money Supply M2 in the United States increased to 11820.30 USD Billion in February of 2015 from 11701.10 USD Billion in January of 2015. This was a significantly higher growth rate than we have seen at any point in the last year, and is a good sign for the economy.
Conclusion: So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Recovery Phase of the Economic Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing, and that the chances of the US economy entering recession anytime soon are very low. For that reason, I remain 100% invested in the TSP S Fund.
Death and Taxes: If you are like me and haven’t quite gotten around to doing your taxes yet, it is about that time. If you are so inclined, you can get TurboTax products at a discount on Amazon through the TSP Allocation Guide’s affiliate link below, and you can also get 10% added to your refund if you take it in the form of an Amazon gift card (so a $1000 refund turns into an $1100 gift card):
The Next Update
I will send out a new update next month after all of this month’s data comes in unless I decide to make a change in my allocation or something shocking happens which requires me to send out a new update. I send out a notification of these updates (or Thrift Savings Plan 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 about once a day at: @TSPallocation
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