THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.
Welcome back for the May 2015 update. These updates seem to be creeping later and later each month as life and work interfere with my creative pursuits, but I do still look hard at the markets and economic news every day.
It has been a fairly eventful month so far – highlighted by the release of first quarter earnings, first quarter GDP numbers, a rebounding jobs report, and some interesting comments from Federal Reserve officials. But none of that has actually moved the market at all in May, with the S&P 500 (TSP C Fund) up just 1% and the Wilshire 4500 (SP S Fund) up about 0.5%.
Bottom Line Up Front
I believe we are still in the recovery phase of the business cycle and so my current Thrift Savings Plan allocation remains 100% in the TSP S Fund (this reflects both my contribution allocation as well as where my existing balances are invested).
Earnings drive stock prices more than anything else, so aggregated earnings growth is always very important to me. Analysts slashed estimates due to fears that the strong dollar would have a dramatic impact on earnings (the strong dollar makes US goods more expensive overseas and hurts sales). As with most things, the analysts went way too far and 71% of companies which have reported so far beat estimates for the quarter. Compared to the first quarter of 2014, S&P 500 earnings were up 2.1% overall. But that doesn’t tell the entire story. The dramatic fall in oil prices has decimated oil company stocks – earnings would be up 10.2% if we excluded energy stocks. And in a display of just how massive Apple has become and how successful it was last quarter, Apple accounted for 75% of that 2.1% growth by itself – if Apple was taken out of the S&P 500, growth would have only be 0.6%.
On May 6, Federal Reserve Chair Janet Yellen put a scare into the market when she warned that stock valuations appear elevated, saying, “I would highlight that equity market valuations at this point generally are quite high.” Which sounds reasonably innocuous, but the financial media reported it like she had announced the apocalypse .
She knows a lot more than I do, but let’s be clear that she isn’t trying to call a market top here. Back in 1996, Fed Chairman Alan Greenspan created a panic when he talked of the market’s “irrational exuberance.” Over the next three years the market doubled. And Yellen singled out valuations in the social media and biotech sectors back in 2014, saying they were “substantially stretched.” The Nasdaq Biotech index is up a 33% since then.
The stock market’s valuation (the simplest measure being its price to earnings ratio) is higher than its historical average right now, so that is true. But interest rates remain very low compared to their historical average. When we look at the meager income which we can obtain from buying bonds (which is really the only other option), we are willing to pay a premium for the yield which we can obtain from holding a share of stock. So in my amateur estimation, the market is at a reasonable valuation in this interest rate environment.
On May 8, the Bureau of Labor Statistics reported that the U.S. economy created 233,000 net new jobs in April. That was basically in line with expectations, but after the terrible report in March this result appeared to show the recovery remains on track and was counted as very good news. The unemployment rate dropped to 5.4%, which is the lowest it has been since 2008.
On April 29, the Bureau of Economic Analysis reported that the U.S. economy grew at a 0.2% annualized rate for the first three months of the year, well below expectations and so poor that when the numbers are revised (as they always are) we could easily see a contraction for the first quarter of the year. A second estimate, based on more complete data, will be released on May 29.
These results by themselves really won’t have any impact on the business cycle strategy. But if we don’t see a bounce up in the second quarter, that would be a red flag and give me cause for concern.
On the plus side, those numbers really put an end to the debate over whether the Fed will raise short term interest rates in June or not. The soonest I believe that is likely now would be September, and even that is probably a 50/50 proposition.
Sell in May
This is the time of year when the click-bait headline writers on financial sites churn out the same, tired attention grabbers which make it sound like Wall Street packs up for the summer and nothing good will happen until Halloween. Volume is lower during summer months and the weaker months of the year historically occur during that time. But parse those numbers a bit more and you find that in non-recessionary years when the markets have been relatively flat in the first five months of the year, they typically outperform during the summer. And even a straight buy and hold strategy over the past 20 years would have resulted in a huge edge over selling from May to October each of those years. If any of the stock market geniuses in your office tell you they are selling in May, you might just do them a favor and show them the chart below (and tell them to send me a dollar):
TSP Fund Performance
We are so close to the end of May that I almost don’t want to talk about TSP fund performance in April, but I know that is one of the more popular sections of the update, so here goes:
Fund April/Year to Date
C Fund 0.96/4.15
S Fund -1.5/6.62
I Fund 4.11/11.63
F Fund -0.28/0.32
G Fund 0.15/0.73
The I Fund:
I continue to spend a lot of time looking at the TSP I Fund and trying to figure out if I am comfortably that it will at least perform at the same level as the TSP S or C Funds and that a significant pull back isn’t likely. If I can’t answer both of those questions, putting money into the I Fund is really just gambling and I would be chasing performance, which is one of the worst things you can do as an investor.
So up until this point I have stayed out. And a year from now the odds are excellent that I will have been wrong to do so. Look, I believe the TSP I Fund is going to be up over that period, and probably more than the TSP S Fund or TSP C Fund. But I also believe there is a much higher likelihood of the I Fund having a significant correction than either of the domestic equity funds. I am more cautious with my Thrift Savings Plan than I am with my outside investments, otherwise I would have certainly moved a percentage over when the European Central Bank announced its stimulus (Quantitative Easing) program.
I have my international exposure outside the Thrift Savings Plan in emerging market funds, which I believe are undervalued compared to the markets represented in the I Fund (which you will remember is a developed market fund and does not include a single share of the stocks from any of the rapidly growing economies such as China and India. Emerging markets are definitely not a safe bet, however, and I’m sure that chart will look like a roller coaster as China tries to maneuver between establishing some order in its financial markets and cutting growth too severely, and as Brazil teeters through impacts of lower oil prices and questionable stewardship of the economy.
So, how clever was I? Since I started building that position in emerging markets back in November (which I discussed in this update), that fund is up about 3.5%, compared to 6.8% for the TSP’s International Fund. So not as clever as I like to think I am. (Although incidentally, the S Fund is up 6.78% over that exact period, so the basic strategy has done just as well over that time).
All that said, I think it is likely I will move about 10% of my Thrift Savings Plan balance into the I Fund in the next few weeks. I will certainly send out an update when and if I do, not because I want anyone to do what I do, but to be completely transparent in what I am doing.
A sizable percentage of the questions I receive are about how I am able to save as much as I do in my TSP and other investment accounts. I’ve done well in the stock market, but I really think the main reason I am where I am today financially has much more to do with putting retirement savings first in my list of priorities as well as other lifestyle choices. This book is already on the recommended reading list, but because I have received so many questions lately I think it is worth highlighting again:
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 an additional email. 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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