Current TSP Allocation and Business Cycle Phase Update – May 2014

This is an archive post. Click here to view the Current Update.

05/15/2014

“The market is down today! The bull market is over! The market is back up, but something doesn’t feel right! Sell everything and go to cash!”

Perspective is everything. The stock market has been up and down a bit this year. It definitely hasn’t done as well as last year. But where are we really after all that excitement?

The DOW set an all-time record high this week.
The S&P 500 (the TSP C Fund) set an all-time record high this week.
The Russell 2000 (the TSP S Fund) is less that 1% below its all-time record high.

Gordon Gekko okay - TSP Allocation GuideDoes this really seem like a time you don’t want to be in the stock market?

This is why we ignore the financial media. If you listened to the noise and have been hiding out in the G Fund because of some week-to-week volatility, you missed those record highs.

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).

But surely, the nice man on TV is going to be correct one of these days, right? “The Bull Market has run its course,” he says. And then the pretty lady says, “we are due for a downturn.” And for good measure the guy with the British accent and the skinny tie throws in something about “technical indicators show…”

The truth is this: Bull markets do not “get tired”. They do not end because a certain amount of time has elapsed. The stock market does not suddenly just reverse course and start to decline over a meaningful period of time.

Tired Bull - TSP Allocation GuideBull markets end when the economy enters a recession. In the history of the modern stock market (since 1966 for today’s purposes) there have been nine bull markets, including the one we are in now. Seven ended when the economy entered a recession. Not because they got “tired” or any other nonsense the communications majors on TV spouted at the time. (No offense to communications majors in other fields – you are doing fine work!)

The solitary exception was the crash of 1987 when the market had the largest one day drop in history on October 19. That was an outlier because the economy had not entered a recession. The crash was caused by a number of unrelated factors which combined to create a short term panic. The market had been on a tear and was up 44% in the first seven months of the year. It was due for one of those five or six corrections which happen every year (which I write about every month). The crash started with the bottom dropping out of the Hong Kong stock market, that spread to the European markets, and then the US market followed. It likely would have been a fairly normal correction in the 10% range (we average one of those per year), but computerized program trading had recently been introduced in the US stock markets. These trading programs were rudimentary at that stage, and didn’t handle the correction well. At a certain point, the algorithms all had a “sell everything” fail safe which executed when the market fell to a certain point. That started a panic, market psychology took over, and the market fell over 22% in a single day.

But what happened next is instructive. The economy was not in recession, so the new bull market started immediately. The day after the crash was the largest point gain in the history of the stock market. And a few days later on October 22, the market crushed that record by 150%. At the end of the year, the S&P 500 was still up 5.2% for the year, and all of the crash’s losses were wiped out in less than two years. Not a great period, but nobody’s retirement accounts were wiped out by the crash except for those who were so frightened that they sold at the bottom and missed the recovery.

Divergence between the TSP C Fund and the TSP S Fund

diverging indices - TSP Allocation GuideThere is a lot of talk right now in the media about the divergence between small cap stocks (which for us means the TSP S Fund) and large cap stocks (the TSP C Fund). And to listen to them, you might believe that it is possible that small caps will fall while while large caps go up over some meaningful period of time.

That is utter nonsense. The small cap and large cap indices trade in parallel over any period longer than a month or two. This “sector rotation” and “flight to quality” is a temporary phenomenon which won’t even show up on a one year chart. Over both the mid and long term, small cap stocks will outperform large cap stocks (by 2.5% on average since 1929). Those charts will come back together and the small caps will pass the large caps. I don’t know if that will happen this month, or next month, or the month after, but it will happen.

That said, this is not a normal recovery. It is possible that in this slow motion recovery the rotation to large caps we generally see after the economy is at full capacity is occurring at a different stage than it typically does. I tend to doubt that, but only time will tell. That hasn’t ever happened before, so frankly I don’t have a way of figuring out if it is happening now. And I don’t think anyone else does either.

TSP Allocation Guide Performance (because at the end of the day, that’s why we are here):

Year to Date: 0.35%

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

Total nonfarm payroll employment rose by 288,000, and the unemployment rate fell by 0.4 percentage point to 6.3 percent in April. Employment gains were widespread.

Even more impressively, job gains averaged 238,000 per month since February – the best three month run since the end of the recession in 2009.

April 2014 Unemployment Rate - 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 from last month. I obtain this data from the Federal Reserve.

Money Supply M2 in the United States increased to 11158 USD Billion in March of 2014 from 11127.30 USD Billion in February of 2014. Money Supply M2 in the United States averaged 3269.52 USD Billion from 1959 until 2014, reaching an all time high of 11158 USD Billion in March of 2014.

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

Money Supply M2 042014 - 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 3.0% year to date, and the TSP S Fund is up 0.35%.

S&P 500 One Year Chart - 05142014(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 recession in the future, we estimate that the expected chance of the economy being in a recession next April at 1.78 percent, down from March’s estimate of 1.81 percent and up a bit from February’s 1.74 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 probability from yield curve(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 April for the 11th consecutive month, and the overall economy grew for the 59th consecutive month, say the nation’s supply executives in the latest Manufacturing ISM® Report On Business®. The April PMI® registered 54.9 percent, an increase of 1.2 percentage points from March’s reading of 53.7 percent, indicating expansion in manufacturing for the 11th consecutive month.

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

PMI 12 month - 05142014So 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. For that reason, I remain 100% invested in the TSP S Fund.

The Other TSP Funds

My views of the other funds remain 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 business 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. The TSP C Fund did better over the past two months because the big damage in the market was inflicted on the biotech and high P/E internet stocks in the NASDAQ, which is disproportionately represented in the TSP S Fund.

TSP I Fund: In addition to what I have said in each update for the last six months, the conflict between Russia and Ukraine has the potential to tip Europe back into recession if uncertainty inhibits earnings, spending and growth. The TSP I Fund may well have some strong months going forward, but I don’t see a basis for predictable gains. 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 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)

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.

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: BDCs 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). Approximately 8% of all shares of these companies are owned by funds benchmarked to the Russell 2000 index, so we may see a significant decline as the funds are forced to sell those shares off. BDCs aim for high yields, and tend to get them in an improving economy such as the one we are in now. Prospect Capital (PSEC) has a 12% yield and BlackRock Kelso Corp. (BKCC) has a yield of 11%. It looks to me like these stocks have flattened out, so much of the anticipate drop is likely priced in, but I expect to see more selling as that June deadline passes and the funds start to sell them off.

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

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

  1. Thank you for the update. I really enjoy the site. I do have a question on where you get your year to date percentage of 0.35%. I was late to the party and moved into the S fund 13 Feb. of this year. I’m down roughly 1.27%. Another site shows the S fund at -0.62% for the year.

    1. Hi Jay. That 0.35 was from the close on Tuesday evening when I was writing the update. The market was down Wednesday before the post went live which is why you saw that lower number. Either way, we are basically flat for the year so far which tends to make me believe we will see some movement sooner rather than later.

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