Current TSP Allocation and Business Cycle Phase Update – June 2014

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

06/08/2014

Relaxed Bull - TSP Allocation GuideMost months I sit down to write this update and the notes spill out over several pages as I organize my views on the behavior of the stock market and the various currents which swirl around it. This month – not so much.

It has been a quiet month. The economic indicators have been consistently positive and the stock market reacted accordingly. The financial media have given up their “This is the End” theme for now and have shifted most of their attention towards really important things, like whether the iPhone 6 will have a larger screen.

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 do I believe that we are still in the Early/Recovery Phase of the Economic Cycle?

economic cycleWe had a wonderful question from Aaron on the message board this week, the response to which I thought everyone might be interested in.

Aaron essentially asked for clarification on why I feel we are still in the early/recovery phase rather than in the mid/growth phase as many pundits believe.

A few of the arguments noted for why we might be in a more advanced stage of the economic cycle: (a) it has been 5 years since we exited the recession, (b) large caps have been outperforming small caps as of late, and mid cycle sectors are outperforming early cycle sectors, and (c) some indicators (such as unemployment) seem unlikely to improve much more before they plateau.

This is exactly why I created this website. My goal was not to have anyone blindly follow my allocations (because for all you know, I could be a 13-year old boy in Taiwan). My goal was to create an environment where we can discuss ideas and perhaps arrive at a consensus, and then readers can take that information and make more informed decisions for themselves.

So my answer is not intended to be the answer, just my opinion for whatever that is worth. The short answer is that I do believe we are still in the early/recovery phase because the characteristics of the economy still line up with those typical of that phase (rapidly improving growth, declining unemployment, low interest rates, low inflation, and improving public sentiment). That said, this recovery has been a long, slow, drawn-out affair, and has certainly been impacted by the Fed’s unprecedented intervention, so the economic cycle phase may not always match up exactly as we would expect with the stock market.

With respect to the length of the current bull market:

  1. as I wrote last month, bull markets don’t get tired or end because of the passage of time. They end when the economy contracts;
  2. for those out there who want to compare this bull market to those of the past, just make sure you are comparing apples to apples. It is true that the median length of a bull market is 50 months, but only if you go back to 1871. The US economy and stock market look nothing at all like they did before World War II, which was when most of the short bull markets which pull that median length down occurred (1872, 1881, 1906, 1909, 1934, and 1937). In modern times, bull markets have typically lasted much longer – in fact, three of the most recent each lasted more than 12 years (1961, 1987, and 2000).

While it is true that large caps have performed more strongly than small caps so far in 2014, I don’t believe that has been caused by a change in the phase of the economic cycle. Instead, I think that was a result of the correction in the biotech/pharmaceutical and internet sectors which disproportionately weighed on the small cap index. That correction seems to be well behind us now, and when you look at the performance of the market over the last month, small caps have dramatically outperformed large caps.

TSP C Fund compared to TSP S Fund

On the final argument, I tend to believe that some indicators are likely to get much stronger or at least continue to improve before they plateau. Unemployment continues to fall, but I believe we are still at least 18 months out from reaching “full employment” at 5.6%. And GDP growth has been very anemic, but eventually I think that will accelerate into the 4-5% range.

But those are just my thoughts. Please weigh in with your own opinions and ideas on that thread on the message board.

TSP Allocation Guide Performance through 06/06/2014 (because it is all about the money):

Year to Date:  5.14%     Last 12 Months: 24.26%

Year to date TSP fund performance:

  • TSP C Fund:  7.41%
  • TSP S Fund:  5.14%
  • TSP I Fund:  6.14%
  • TSP G Fund:  1.01%
  • TSP F Fund:  3.57%

The May 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: the May 2014 jobs numbers come from the Bureau of Labor Statistics:

Total nonfarm payroll employment rose by 217,000 in May, and the unemployment rate was
unchanged at 6.3 percent.

Declining unemployment historically has been the best predictor of a rising stock market, so this is exactly what we want to see.Unemployment Rate May 2014 TSP Allocation Guide

(2) money growth: no new numbers this month for 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), so this is a repeat again. I obtain this data from the Federal Reserve.

Money Supply M2 in the United States increased to 11158.70 USD Billion in March of 2014 from 11127.30 USD Billion in February of 2014. Money Supply M2 in the United States averaged 3269.59 USD Billion from 1959 until 2014, reaching an all time high of 11158.70 USD Billion in March of 2014 and a record low of 286.60 USD Billion in January of 1959.

This continued upward trend is what we are looking for to confirm we are in the recovery phase:

Money Supply M2 May 2014 TSP Allocation Guide(3) 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. The TSP C Fund is up 7.14% year to date, and the TSP S Fund is up 5.41%.

(4) yield spreads: I obtain my data for this section from the Cleveland Federal Reserve. The yield curve flattened slightly last month, but the spread remains huge, which indicates a very, very low probability of recession. 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 May at 2.31 percent, up a bit from the April estimate of 1.78 percent, and down from 1.81 percent in March. 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 probability from yield curve - TSP Allocation Guide June 2014(5) 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:

Economic activity in the manufacturing sector expanded in May for the 12th consecutive month, and the overall economy grew for the 60th consecutive month, say the nation’s supply executives in the latest Manufacturing ISM® Report On Business®.

 

The May PMI® registered 55.4† percent, an increase of 0.5 percentage point from April’s reading of 54.9 percent, indicating expansion in manufacturing for the 12th consecutive month. The New Orders Index registered 56.9† percent, an increase of 1.8 percentage points from the 55.1 percent reading in April, indicating growth in new orders for the 12th consecutive month. The Production Index registered 61.0† percent, 5.3 percentage points above the April reading of 55.7 percent. Employment grew for the 11th consecutive month, registering 52.8† percent, a decrease of 1.9 percentage points below April’s reading of 54.7 percent. The Supplier Deliveries Index registered 53.2† percent, 2.7 percentage points below the April reading of 55.9 percent.

 

Comments from the panel reflect generally steady growth, but note some areas of concern regarding raw materials pricing and supply tightness and shortages.”

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

12 Month PMI June 2014 TSP Allocation GuideSo 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

My views of the other funds remain largely unchanged from last month, but I have copied those here for new readers:

TSP C Fund: The C Fund will perform fine, but historically the TSP S Fund will outperform in this phase of the economic cycle. 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.

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. 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: The surprise fall in interest rates has the TSP F Fund doing better this year than I had expected. But the Fed’s continued taper of Quantitative Easing will likely result in interest rates continuing to trend 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).

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)

individual stocksThis 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.

I don’t have particularly strong feelings about any individual stocks these days. If I had money I was going to put to work right now it would go into a small cap value fund like Vanguard’s VBR. My larger individual holdings have done well with the market’s recent upturn (Apple, Google, Facebook). And even Amazon, which has done terribly so far this year, rallied nicely on rumors of the launch of their own smart phone.

We have talked about Biotechs over the past few months as they were hit very hard. I believe the damage has been done and they are due to rally, so I think this is a good entry point for someone looking for exposure in this high flying area. My favorites remain Celgene (CELG), Gilead Sciences (GILD), and Keryx Biopharmaceuticals (KERX). (I currently own CELG and KERX in my non-retirement portfolio.)

Business Development Companies: I have discussed BDCs a few times over the past few months. They are going to be removed from Russell indexes in June (not because there is anything wrong with them, but because they are basically leveraged stock holding companies so their inclusion results in the stocks which they hold being counted twice). I still would not be in a rush to buy BDCs at this stage – there is some potential for a sharp drop prior to those leveling out.

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

What’s in it for me?

I don’t ask anything of readers except that they share the site with their colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment. You can do that by linking to this site from your own webpage or blog; spreading the word on Facebook, Twitter and in other investing forums; or actively participating on our Message Board.

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2 thoughts on “Current TSP Allocation and Business Cycle Phase Update – June 2014”

  1. TS Paul:

    I joined your list of followers, I believe, in Feb 2014. Moved all the money to the S Fund, and stroke gold! Rode that high wave, smiling! Then spent days learning your strategy, even made a little business cycle chart for my visual comprehension of the strategy; my brain went on hyper-drive. At the moment my PIP went up from 4 percent to 16 percent, and it was reflected in my money balance. Couldn’t be happier, and hugely appreciative. Then Mar and Apr showed losses, and the money made was gone, then some.

    That experience took me to the realization of what you said is so true: you have to stick to the plan, even if you experience a reversal! Not easy to do. Just hanging in there, fine tunning my learning of the strategy, and looking for the opportunity to contribute my own comments, and pose a question.

    That opportunity just came up. In seeing the consumer confidence index at http://www.tradingeconomics.com/united-states/consumer-confidence, I ask if this could be a sign that the business cycle is moving from the recovery stage to the growth stage, suggesting to spread the current 100 percent investment on the S Fund to 75 percent S and 25 percent C? I know the consumer confidence index is not one of the preferred five indicators you follow, but it may influence one of the five, possibly the PMI.

    I remain 100 percent S, but as I told you in an earlier note, I want to learn to fish, not wait for you to hand me the fish you catch. Knowing that you and your constituents, blog followers, are a group of forward leaning thinking persons with a common interest to learn and grow, and reach retirement with a larger purse, I pose the question and wait for comments.

  2. Thanks very much for all the kind words – it really does make me feel good to know that some folks are getting value from my little project.

    Jumping back up to Izzy’s question – consumer confidence isn’t one of the indicators I really track. The American public – how can I put this nicely – isn’t always a great judge of where the economy is at any given time and is at best a trailing indicator. In July 2013, four years after the recession ended, more than half of all Americans still believed we were in recession…

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