Current TSP Allocation and Business Cycle Phase Update – February 2014

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02/13/2014

Recent Market Downturn

Stock Market CorrectionSince the current bull market began in March 2009, we have seen 19 downturns or “corrections” of 5% or more. Corrections are a natural part of market behavior, they will happen, and nobody can accurately predict their start date or their duration. So should we have hidden on the sideline to miss those 19 terrifying corrections? During that same period the TSP S Fund is up 218% and the TSP C Fund is up 140%, so ignoring them has been a pretty solid strategy.

You may remember me saying last month:

A “correction” at some point during this year is just as likely as it is every year, so let me go ahead and predict that one will happen just so I can point to this when it does and say I told you so. But the timing of that correction is not something we can predict so the value of knowing that those routinely occur is the comfort that we can take from knowing the market also routinely recovers from those corrections in fairly short order.

 

Since World War II there have been 88 stock market declines of 5% or more. In 57 of those instances the market recovered to break-even in less than two months.
Based on all of the indicators which I follow, I am very comfortable that the economic recovery is continuing. In the business cycle strategy which I follow, you only change investments when you believe the economy is entering a new phase and ignore the unpredictable blips and aberrations along the way. The only possible exception to that rule for me is if a major external event which has the potential to cause long-term disruptions to the markets exists. (An example of such an event might be the 2011 European sovereign debt crisis).

Based on all of the indicators which I follow, I am very comfortable that the economic recovery is continuing. In the business cycle strategy, you only change investments when you believe the economy is entering a new phase and ignore the blips and aberrations along the way. The only exception to that rule is if a major external event which has the potential to cause long-term disruptions to the markets exists (such as the 2011 European sovereign debt crisis).

Read more at: http://www.tspallocation.com/forums/topic/current-downturn-2/ | TSP Allocation Guide

Volatility and bad news are good for the media. People watch CNBC, read the business section of the paper, and click on links to articles about “Bear Markets” and “crash” and “correction.” That sells advertisements, so the media has a powerful incentive to hype the correction meme. Just as an example, the two weeks with by far the most traffic to this website came during January as the financial press whipped the public into a panic over the “meltdown.” If I were so inclined, I could have written an update with a scary title, sent out an email and a tweet, and seen 20,000 page hits in a few hours.

Volatility is good for Wall Street. As I mentioned in one post or another, more trading (either up or down) allows the high frequency trading computers to jump in front of your order (and every order) to extract a fraction of a cent from each share purchased or sold. The firms turn those fractions of a cent into billions of dollars annually.

Where do we go from here? I don’t know (and neither does anyone else). My sense is the recent downturn is over and we will resume the upward trend (albeit at a slower rate than we saw in November and December). But we could see the market trade flat for a while. Or we could see it trade down a bit more. I told you I didn’t know. At any given time, I can always confidently predict the market will suffer a correction sometime in the next 12 months. Just as I can predict that it will recover its losses relatively quickly after doing so in all but one phase of the business cycle. That is the nature of the market.

The January Barometer Myth

January Barometer Myth“There are three kinds of lies: lies, damned lies, and statistics.”

The January barometer is accurately described in my separate post on this myth as a “Neanderthal statistic.” In a nutshell, if you cherry-pick the right statistics you can prove just about anything you want in the stock market. In actual fact, the January Barometer accurately predicts negative market returns for the full year following a down January just 33% of the time. (That means it is wrong 66% of the time.) For the full explanation please see my post Debunking the January Barometer Myth.

The January Numbers

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)

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

(1) employment numbers: the Bureau of Labor Statistics released the January 2014 jobs numbers. The results were not particularly impressive, but still moving in the right direction:

The unemployment rate declined from 6.7 percent to 6.6 percent in January, and total nonfarm payroll employment rose by 113,000.

 

US Unemployment Rate January 2014 - TSP Allocation Guide

(2) 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). I obtain this data from the Federal Reserve.

Money Supply M2 in the United States increased to 10958.8 USD Billion in December of 2013 from 10908.9 USD Billion in November of 2013. This continued upward trend is what we are looking for to confirm we are in the recovery phase:

US Money Supply M2 - TSP Allocation Guide(3) the stock market: as described above, we certainly had a correction since the beginning of the New Year, but I look at trends across months and quarters, not days or weeks.
Current Bull Market - February 2014 - TSP Allocation Guide
(4) yield spreads: I get my data for this section from the Cleveland Federal Reserve. The Cleveland Fed notes:

Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.3 percentage rate over the next year, just barely above the 1.2 percentage rate seen in November and December. The influence of the past recession continues to push toward relatively low growth rates. Although the time horizons do not match exactly, the forecast is slightly more pessimistic than some other predictions but like them, it does show moderate growth for the year.

The yield spread remains huge, which indicates a very, very low probability of recession, and it continues to trend in the right direction:

Yield Spread - January 2014 - TSP Allocation GuideThe below chart shows the historical probability of recession based on where the yield curve is now:

Recession Probability based on Yield Curve Chart October 2013

(5) Purchasing Managers’ Index (PMI): as usual I went to the Institute for Supply Management and pulled up their most recent report (remember that any number above 50 indicates economic growth):

Economic activity in the manufacturing sector expanded in January for the eighth consecutive month, and the overall economy grew for the 56th consecutive month, say the nation’s supply executives in the latest Manufacturing ISM Report On Business®

 

The January PMI® registered 51.3 percent, a decrease of 5.2 percentage points from December’s seasonally adjusted reading of 56.5 percent. The New Orders Index registered 51.2 percent, a significant decrease of 13.2 percentage points from December’s seasonally adjusted reading of 64.4 percent. The Production Index registered 54.8 percent, a decrease of 6.9 percentage points compared to December’s seasonally adjusted reading of 61.7 percent. Inventories of raw materials decreased by 3 percentage points to 44 percent, its lowest reading since December 2012 when the Inventories Index registered 43 percent. A number of comments from the panel cite adverse weather conditions as a factor negatively impacting their businesses in January, while others reflect optimism and increasing volumes in the early stages of 2014.

The following table continues to show a consistent trend indicating expansion over the past year, however the January pullback will bear watching:

PMI 12 Month Chart - January 2014So again, all of the indicators are pointing in the same direction, and I believe that we remain in the Recovery Phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing. And so I remain 100% invested in the TSP S Fund.

The Other TSP Funds

So I’ve told you that I think we remain in the recovery phase of the business cycle, and that small caps (the TSP S Fund) typically perform best during this phase. But what do I think about the other funds?

TSP C Fund: I believe the C Fund will perform well over the next quarter, perhaps even on par with the S Fund. But historically, in this phase of the business cycle the S Fund will outperform and you really aren’t diversifying by choosing a slightly different basket of US stocks, so I don’t see any value in splitting my allocation. Even with as poorly as the market has done so far in 2014, year to date the TSP S Fund (which is supposed to be more volatile) has done better than the TSP C Fund.

TSP I Fund: (No change from last month) The economies which underlie the TSP I Fund continue to have very mixed data. High unemployment rates and low GDP growth in Europe leave me unconvinced that the TSP I Fund is likely to outperform the domestic funds. For that reason, I won’t consider the TSP I Fund until I see stronger signs of growth in Europe. The TSP I Fund may well have some strong months going forward, but I don’t see a basis for predictable gains because of Europe’s unsteady recovery. Japan is a different story, and I have taken a position in the Japanese market in my non-TSP investments because economic growth is strong, and more notably, there is a move to expose more of the 80%+ of Japanese pension funds which are currently in cash (totaling trillions of dollars) to the stock market. If you haven’t read it yet, I’ve got 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: (No change from last month) The Fed’s taper of Quantitative Easing will likely result in interest rates continuing to trend up, which will result in 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).

TSP G Fund: (No change from last month) The G Fund would be my safe haven of choice these days, if I needed a safe haven. 1.5% annual return is dreadful, but it beats negative numbers which you might well see with the F Fund going forward.

TSP L Funds (the lot of them): (No change from last month) 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.

TSP Allocation Guide Performance

Year to Date: -1.09%

12 month: 26.20%

2013: 38.35%

Individual stock picking for fun (and occasional profit)

This non-TSP talk is for fun, not at all a recommendation to buy. The vast, vast majority of my investments 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.

I’ve run out of time tonight so I won’t share anything new and just update you on how my double predictions for 2014 have performed:

Facebook (FB): up 37.5% since I first mentioned buying in my twitter feed on 12/3/13, and up 17.8% year-to-date. I wish I had bought more.

InSite Vision (INSV): down 10% year-to-date (but safely holding that .26 lower range (for now, at least)). I thought that mid-December spike was going to have some more follow through, but it is early in the year yet and it has plenty of time to make a run.

The Next Update

Unless something dramatic happens, I will update this post again during the second week of next month after all of this month’s data comes in. 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 which you can follow: @TSPallocation

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

  1. I currently have all my funds in the L2030 fund and have been investing for the last 4 years in it. Would you recommend transferring my entire balance to the S fund? Thanks for the advice.

    1. I can’t give individual advice on this website, but it is certainly no secret that I am currently 100% in the TSP S Fund. Only you can decide if that is the right allocation for you, and I earnestly hope that you will read a lot more than just this site before you make that decision. The L 2030 has done pretty well over the past few years, so you are off to a great start.

  2. Is the new update coming soon? Looks like everything still points to being in a recovery phase. All numbers are on par with 1-5 of the items above. I did notice unemployment rate went from 6.6 in Jan to a 6.7. But 175,000 jobs were created.

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