THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.
The Market Awakens
Since 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 percent. I 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.
Purchasing 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:
Yield 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.
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.
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.
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.
- Japan: Japan indicators summary page
- United Kingdom: UK indicators summary page
- France: France indicators summary page
- Switzerland: Switzerland indicators summary page
- Germany: Germany indicators summary page
(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:
The Next Update
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