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