Current TSP Allocation and Business Cycle Phase Update – August 2014

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

08/11/2014

Washington DC SupermoonThe stock market was really pretty boring this summer until the end of July. It went more than two and a half months without a daily move in either direction of 1% or more – the longest streak of its kind in nearly 20 years. The end of July and early August have been a bit more interesting for investors who look at daily changes, but I don’t read too much into our new-found volatility – it is just a return to normal.

The economic indicators we track show the US economy continues to grow and accelerate. July saw a great jobs report – the economy created 200,000 new jobs for six months in a row for the first time in 17 years. And the PMI clocked in at its highest level in more than three years.

Bottom line up front: 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).

Why you shouldn’t look at the stock market every day

original apple logoFrom this time in 2003 to the present, stock in Apple is up 3,141%. While any of us would be delighted to hold an investment which appreciated in that manner, that isn’t a typical rate of return. But there is one aspect to Apple’s dizzying rise which is very typical of the market as a whole and is therefore instructive to anyone who might be tempted to worry about their TSP’s daily performance – Apple was down on 48% of the trading days during those eleven years.

That is the nature of the stock market as well. In the short term it goes up and down every day in fairly random fashion (fortunately over time it goes up more than down). But man is a pattern seeking creature, so we search for clues in the mountains of data which are created by the market every day. Pattern seeking helped humans immensely when we were hunters and gatherers as it made it possible for us to quickly figure out where food and game were most likely to be found, but it is almost completely inapplicable to the daily movements of the stock market. The fact that an entire industry has sprung up around this fiction is a testament to confirmation bias – the tendency for people to search for and interpret information in a manner which favors their hypothesis or beliefs. The chartists who tilt their heads and squint at contrived graphs to find the “head and shoulders” or “double bottoms” would be just as successful if they were throwing chicken bones and reading the results. This school of investing was widely discredited after it peaked in the 1970’s, but it has hung grimly on because after any market movement someone can always produce a chart which perfectly predicted what was going to happen (and confirmation bias leads adherents to ignore the hundreds of other charts which predicted the opposite).

We universally overestimate the short term and underestimate the long term. Unless and until you can train yourself to see daily, weekly and even monthly moves as entertaining but unpredictable noise (even when they occasionally pass the 10% mark), you should probably just check your returns quarterly.

News of the World - TSP Allocation GuideHow today’s news impacts your TSP

The financial media loves to try to attribute those random daily moves to the day’s headlines. On one particularly entertaining day last week, the lead headline in three different financial publications attributed the market’s down day to three completely unrelated events. Correlation is not the same as causation, and most headlines have absolutely no impact on the stock market. As examples:

 

Ebola: this “terrifying epidemic” has killed fewer than 3000 people in the last 40 years. That many people die in car accidents in the US every 40 days. Thirty-nine million people have died of AIDS during that period. Ebola will not effect the stock market.

 

Ukraine: at this point, nobody is going to be surprised if Russia invades eastern Ukraine under the guise of peace keeping or humanitarian assistance. If that happens, it isn’t going to turn into World War III and it isn’t going to impact your TSP for more than a few days.

 

Israel/Gaza: while the conflict has made for good television and our politicians are lining up to “stand behind Israel” to ensure they get the AIPAC endorsement, it has zero impact on the US economy.

 

Iraq/Syria/Libya: that whole “spreading peace and democracy through regime change” thing has turned out to be tougher than we thought, but the good news is that a few aerial bombing runs against an armed rabble doesn’t ever have any impact on the stock market for more than a few hours (those few hours during which people who believe it might have an impact sell their shares to people who have an investing horizon which extends beyond happy hour).

Argentina defaults on debt/Portuguese bank fails/etc.: these events are a real shame if you happen to be speculating in Argentinian bonds or certain Portuguese penny stocks, but while they give the financial media something to wring their hands about, they don’t effect the TSP funds a bit.

So what does move the market?

To be sure, there is news out there which moves the market. And that is news which impacts the economy. Take a look at the extraordinary chart below which was created by reader who is much better at this sort of thing than I am. (The kids out there reading this on their smart phones and watches will have a very hard time seeing this, but trust me when I tell you it is worth opening up on a full sized screen.)

TSP Fund Graph - TSP Allocation GuideWhen you look at the chart, there are a lot of random ups and downs, but the significant moves all appear related to either Federal Reserve activity or significant disruptions to US or European financial structures. What I find most interesting about this chart is the apparent relationship between the Fed’s taper of Quantitative Easing and the flattening of the stock market since the beginning of January – apparently when they started to close the spigot on the $85 billion per month they had been pumping into the economy it had a clear impact on the stock market.

TSP Allocation Guide Performance through market close on 08/11/2014:

Year to Date:  3.85%

Year to date TSP fund performance:

  • TSP C Fund:  7.07%
  • TSP S Fund:  3.85%
  • TSP I Fund:  1.99%
  • TSP G Fund:  1.42%
  • TSP F Fund:  4.56%

The July Economic Numbers

As always, I will run through the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me (these indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle):

(1) employment numbers: as described above, the July 2014 jobs numbers were very strong and cap off a run of six strong months. I obtain these from the Bureau of Labor Statistics:

Total nonfarm payroll employment increased by 209,000 in July, and the unemployment rate was little changed at 6.2 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in professional and business services, manufacturing, retail trade, and construction.

unemployment rate August 2014 - Thrift Savings Plan Allocation Guide

(2) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report. Any number above 50 indicates economic growth, and this month’s reading of 57.1 is the highest in more than three years:

Economic activity in the manufacturing sector expanded in July for the 14th consecutive month, and the overall economy grew for the 62nd consecutive month, say the nation’s supply executives in the latest Manufacturing ISM® Report On Business®.  The July PMI® registered 57.1 percent, an increase of 1.8 percentage points from June’s reading of 55.3 percent, indicating expansion in manufacturing for the 14th consecutive month. The New Orders Index registered 63.4 percent, an increase of 4.5 percentage points from the 58.9 percent reading in June, indicating growth in new orders for the 14th consecutive month. The Production Index registered 61.2 percent, 1.2 percentage points above the June reading of 60 percent. Employment grew for the 13th consecutive month, registering 58.2 percent, an increase of 5.4 percentage points over the June reading of 52.8 percent. Inventories of raw materials registered 48.5 percent, a decrease of 4.5 percentage points from the June reading of 53 percent, contracting after five months of consecutive growth. Comments from the panel are generally positive, while some indicate concern over global geopolitical situations.

The following table shows the progression of the PMI over the last year:

PMI August 2014 TSPAG

(4) yield spreads: I obtain my data for this section from the Cleveland Federal Reserve. The Cleveland Fed notes:

Using the yield curve to predict whether or not the economy will be in a recession in the future, we estimate that the expected chance of the economy being in a recession next July at 2.46 percent, up from June’s reading of 1.99 percent and still above May’s probability 2.31 percent. So although our approach is somewhat pessimistic with regard to the level of growth over the next year, it is quite optimistic about the recovery continuing.

The below chart shows the historical probability of recession based on where the yield curve is now:

Recession Probablility from Yield Curve August 2014 TSP Allocation Guide

(4) money growth: 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) continued to grow in June 2014. I obtain this data from the Federal Reserve.

Money Supply M2 in the United States increased to 11351.40 USD Billion in June of 2014 from 11302.80 USD Billion in May of 2014.

Money Supply M2 June 2014 TSPAG(5) the stock market: a trailing indicator as it relates to the economy for the most part, but worth tracking on a monthly basis for signs of significant disruptions. While we have seen a bit more volatility lately, we are still within a hair’s breadth of all-time market highs so I don’t see any signals here to worry about.

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. For that reason, I remain 100% invested in the TSP S Fund.

The Other TSP Funds

TSP C Fund: The C Fund will likely perform just fine and roughly parallel to the TSP S Fund, but historically the S Fund will outperform in this phase of the economic cycle. I believe that when we break out of the summer doldrums the S Fund will outperform the C Fund.

TSP I Fund: I still don’t see a basis for predictable gains in the TSP I Fund. I believe it is likely to be volatile, and is as likely to be down for the year as up. Japan’s recovery appears to have stalled for now, and for every bit of good news out of Europe there is something at least equally bad. Italy fell back into recession in July with its second month in a row of contracting GDP. If you haven’t read it yet, I have a post on the TSP I Fund which explains under what circumstances it performs well here: The Best International fund of the 1970’s Today.

TSP F Fund: The  Fed’s continued taper of Quantitative Easing will likely result in interest rates trending up, which will typically result in flat to negative returns for the TSP F Fund until they stabilize (see the F Fund vs G Fund post for the details on why that will happen). But that’s what we said at the beginning of the year and interest rates surprised everyone by staying low. Eventually that has to give and the F Fund will suffer.

TSP G Fund: The TSP G Fund would be my safe haven of choice these days, if I needed a safe haven.

TSP L Funds (the lot of them): If an investor just doesn’t want to bother looking at things for 40 years, an L Fund would be better than the default TSP G Fund. But I believe we can do better than the mediocre-to-average returns which the L Funds are engineered to achieve.

Individual stock picking for fun (and occasional profit)

stock traderDisclaimer: This non-TSP talk is for fun, not at all a recommendation to buy. The vast, vast majority of my investments outside the Thrift Savings Plan are in great big index funds, not individual stocks. While I have had some great winners over the years, overall I would have been much better off if I had put all of the money I have invested in individual stocks into those index funds. So this is Vegas money, just for fun. Really.

Express Scripts (ESRX): My latest individual stock purchase is ESRX, which I like because I think we’re going to see double digit growth going forward for the foreseeable future due to the approximately 8% free cash flow they generate (which they can plow into share repurchases) and the growth in the number of prescriptions across the industry due to the US’ aging population as well as expanded health insurance availability.

After discussing Business Development Companies (BDCs) regularly over the past six or eight months, I finally started buying into positions in several BDCs to go with my existing REITs. My goal is to create a small fund of dividend generators. I am averaging in, so I will add to these positions over the next year to play it safe to some degree. These companies are all very interest rate sensitive, so as rates climb I fully expect the share prices to be volatile and to see paper losses in double digit percentages. But because I expect to hold the stocks over the long term (and well beyond this phase of rising interest rates), I expect those share prices to recover to at least break even. The point of these companies is that they are required to pay out at least 98% of income and capital gains in the form of dividends in order to avoid paying a 4% excise tax, and they do so at a rate of 8-12% annually.

The income generating companies I am buying now (and their annual yield):

  • NLY / 10.3%
  • AGNC / 11.0%
  • ARCC / 8.8%
  • BKCC / 9.5%
  • FSC / 10.4%
  • PSEC / 12.8%
  • KCAP / 12.4%

My largest individual position remains Apple (AAPL). It is much too large a company to double or triple for me again, but it has the world’s highest market cap for a reason and has a very reasonable P/E ration of 15.5 so I do think it still has plenty of upside potential. I think we will see huge sales when the iPhone 6 hits the market next month and I still believe Apple has the potential to develop new market changing products as it did with the iPod, iPhone and iPad in the past. I think Apple’s recent partnership with IBM to target the corporate world has the potential to incrementally increase revenues over the next few years as well. I would not be surprised to see it up 10% in the next six months.

The Next Update

I will update this post again during the second week of next month after all of this month’s data comes in unless something shocking happens which requires me to send out a new update. 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 once or twice a day at: @TSPallocation

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3 thoughts on “Current TSP Allocation and Business Cycle Phase Update – August 2014”

  1. I’m a first time reader. I’m an ex-hedge fund guy. This is outstanding work and a huge benefit to readers.

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