Current Thrift Savings Plan Allocation and Business Cycle Phase Update – November 2013

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

Updated 11/14/2013: My current Thrift Savings Plan allocation remains 100% in the TSP S Fund.

Year to date returns (as of 12/01/2013): 34.4%

Government Shutdown/Debt Limit Post Mortem

The government shutdown and debt limit crisis dominated the news for Feds last month and my overflowing mailbox reflected the concerns which people had about the potential impact it would have on their Thrift Savings Plan balances. There was a bit of panic out there, which is why I put out an update addressing my thoughts on the issue and indicating that I was remaining 100% in the TSP S Fund. At some point I will combine that update with the post I wrote on Discrete Events and why the business cycle investing strategy is not impacted by headlines. The shutdown and debt limit “crises” fell squarely into this category.

The shutdown, as painful and stressful as it was for Feds, really had no impact on the economy and certainly wasn’t something which could lead the US economy into recession. The debt limit issue could have serious consequences for the economy if it was really in any danger of not being lifted, but that was never a possibility. Speaker Boehner announced early on that he would not allow the ceiling to be breached, so all the soundbites and drama were just theater concocted by politicians trying to get on TV and the media trying to get us to keep watching their advertisements. While no doubt a few of the Tea Partiers would have let the US default on its debts, the GOP is tied much too closely to Wall Street to allow something like that to happen. Even Ted Cruz – the initial leader of the Suicide Caucus – has incredibly close ties to Wall Street and disappeared from the debate after getting his time in spotlight. Cruz’s wife is a Vice President at Goldman Sachs. Goldman Sachs is one of Cruz’s largest campaign contributors, is where he invests his not-inconsiderable wealth, and Goldman has advanced him a huge margin loan. Does anyone really think that Cruz, or McConnell, or Boehner, or any other national level Republican is going to bite the hand that feeds them? And clearly all that money has bought Wall Street access to information which we don’t have – did you notice how the market rallied before any breakthroughs in negotiations had been announced? Wall Street knew exactly what was coming and when, and they profited handsomely on the chaos which Congress had created.

I read a lot of investment newsletters and blogs. And more than a few of the people who write those got nervous and moved their money out of the stock market to “protect it”, both in this situation and earlier in the year because of other headline grabbing events. If you go back and look at when they announced they were pulling their money out, almost inevitably the following day the stock market hit a new all-time high and then continued higher. After a few days they would sheepishly move their money back into the stock market with some rationalizing about how they had done the safe thing. And that’s fine – sleeping well at night is worth more than money, and if being in the market is causing you stress, you are better off not being there.

But here’s what you forgo by being out of the market. Let’s say you are a mid-career, fairly high paid Fed who has maximized your Thrift Savings Plan contributions and made solid decisions with your investments. So you have $500,000 in your Thrift Savings Plan. Now let’s say in the past year you pulled your money out of the TSP S Fund and put it in the G Fund four times when something hit the news which might “make the markets nervous.” Let’s be conservative and say that each of those four times when you were out of the market for a few days to a week you missed out on a 2.5% increase in the market. That’s 10% in the past year. That’s $50,000.

Keep Calm and Compound On - TSP Allocation Guide

But that is nothing. You have another 20 years on the job. And let’s say another 20 years after you retire before you were going to want to use that portion of your Thrift Savings Plan balance, so it remains invested for 40 years. So that $50,000 was going to compound for 40 years at, let’s say conservatively, 8% annually. Go to the Compound Interest Calculator at Investor.gov and run the numbers. That comes out to $1,086,226. That’s over a million dollars you don’t have in retirement because you were out of the market for a few weeks in 2013. Change the number so you average 10% returns annually over that period and you are up to $2.2 million.

Compounding is magic. It is why you have to invest as much as you can in the Thrift Savings Plan when you are young. And it is why you can’t afford to be out of the market when it is going up.

The Looming Correction

There have been a lot of headlines over the past few weeks warning that the stock market is due for a “correction”. That means one of two things to me: (1) there isn’t another good story out there so the media is trotting this one out again because they know that it will get page views, or (2) some of the folks who control the levers on Wall Street have decided to stage a “bear raid” by pulling the bottom out of the market for their own advantage and are priming the public to panic and sell when they do so.

I believe there is an excellent chance the market will have a dip of 10% or more for no particular reason in the next year and will then relatively quickly recover. So why don’t I pull my money out of the TSP S Fund to protect it and buy back in at the lower prices? Because I would have said exactly the same thing a year ago today and I would have missed out on a 31% return on my balance. Unless you are a major investment bank and can pull a billion dollars out of the market tomorrow to trigger stop losses and machine trading algorithms, you can’t predict when this sort of drop is going to come. Taking that sort of loss is going to happen if you are invested in the market, but the upward trend during all but the recessionary phase of the economic cycle will quickly reverse those losses.

The October Numbers

As always, I will run through the indicator data I used in determining where we are in the economic cycle and what it means to me in making my Thrift Savings Plan allocation:

(1) employment numbers: This month I went back to the Bureau of Labor Statistics for the October 2013 numbers:

Total nonfarm payroll employment rose by 204,000 in October, and the unemployment rate was little changed at 7.3 percent. Employment increased in leisure and hospitality, retail trade, professional and technical services, manufacturing, and health care.

Both the number of unemployed persons, at 11.3 million, and the unemployment rate, at 7.3 percent, changed little in October. Among the unemployed, however, the number who reported being on temporary layoff increased by 448,000. This figure includes furloughed federal employees who were classified as unemployed on temporary layoff under the definitions used in the household survey.

 

Unemployment Rate Chart - TSP Allocation GuideAs you can see in this chart, the unemployment rate continues to decline which is symptomatic of the recovery phase in the economic cycle.

(2) money supply growth: I obtain this data from the Federal Reserve:

Money Supply M2 in the United States increased to 10953 USD Billion in October of 2013 from 10819 USD Billion in September of 2013. This continued upward trend is what we are looking for to confirm we are in the recovery phase:

Money Supply M2 October 2013 - TSP Allocation Guide
(3) the stock market: the stock market (which I consider to be a trailing indicator even though the Wall Street types like to think that the market predicts the economy) resumed its upward trend last month, setting multiple new record highs in the process.
S&P Chart November 2013 TSP Allocation Guide
(4) yield spreads: I continue to get my data for this section from the Cleveland Federal Reserve. The yield spread is huge, which indicates a very, very low probability of recession, and it continues to trend in the right direction:

Yield Curve Table October 2013 - 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 October for the fifth consecutive month, and the overall economy grew for the 53rd consecutive month. The PMI registered 56.4 percent, an increase of 0.2 percentage point from September’s reading of 56.2 percent. The PMI has increased progressively each month since June, with October’s reading reflecting the highest PMI in 2013. The New Orders Index increased slightly in October by 0.1 percentage point to 60.6 percent, while the Production Index decreased by 1.8 percentage points to 60.8 percent. Both the New Orders and Production Indexes have registered above 60 percent for three consecutive months. The Employment Index registered 53.2 percent, a decrease of 2.2 percentage points compared to September’s reading of 55.4 percent. The panel’s comments are generally positive about the current business climate; however, there are mixed responses on whether the government shutdown and potential default have had any effect on October’s results.

The following table shows a strong pattern of improvement in the PMI:

PMI Last 12 Months Table - TSP Allocation GuideSo again, all of the indicators are pointing in the same direction, and I believe that we remain in the Expansion/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 Funds

TSP C Fund: I believe the TSP C Fund will perform well over the next quarter, perhaps even on par with the TSP S Fund. But historically, in this phase of the business cycle the S Fund will outperform. Many people will look at returns month by month and see a fractional difference in the return between the two, but those fractions add up. The difference between being 100% in the S Fund and 50% S/50% C Fund from 10/01/2012 to 10/01/2013 would have been 6%. For our hypothetical Fed described above that would have been a $30,000 difference in returns.

TSP I Fund: The economies which underlie the TSP I Fund continue to have very mixed data. Cash inflows (new money) into the European markets hit record highs last month which should have been a very positive sign, but that was followed almost immediately by news that growth in the European GDP is still very anemic and well below that of the United States. For that reason, I won’t consider the TSP I Fund until I see stronger signs of growth. It may well have some strong months going forward, but I don’t see a basis for predictable gains.

TSP F Fund: All indications are that the Fed’s taper of Quantitative Easing (in which the Fed is printing and pumping $85 billion per month into the bond market to hold interest rates down) will not start until at least March 2014 and perhaps even later in the year. That has dropped interest rates so the TSP F Fund may do well the next few months and will likely outperform the TSP G Fund. But keep a close eye on the Fed, because when the taper starts and interest rates rise, the TSP F Fund will do very poorly again (see the F Fund vs G Fund post for all the gory details).

TSP G Fund: 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): If a Fed just doesn’t want to bother looking at things for 40 years, a TSP LifeCycle fund would be better than the default G Fund. But if you have read this far you clearly have the initiative to take a look at where we are in the economy once a month or once a quarter and do something smarter with your money.

As an aside, whenever I refer to my allocation, that reflects both my contribution allocation as well as where my existing Thrift Savings Plan balances are invested. When I change my allocation, I both change my contributions and do an interfund transfer to reflect my current fund choices.

My personal returns

I have received a number of requests for the personal returns I have obtained using the business cycle strategy. I made a very conscious decision when I started this blog that I would not claim performance from before that first posting at the beginning of 2013. Call me a cynic, but I don’t trust things I can’t see for myself. If I were reading an investing blog which started at the beginning of this year and the writer was claiming great returns back in 2009 I would be inclined towards skepticism.

That said, I certainly understand why people would like to see how business cycle theory returns line up compared to the various TSP funds. I will do some research and see if I can’t find some verifiable returns from someone who has been publishing on this subject a little longer than I have to put onto a chart.

 

The Next Update

Unless something dramatic happens, I will update this post again around this time in the second week of December after all of the November data comes in. I send out a monthly notification of these updates (or allocation changes) 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 a few times a day which you can follow: @TSPallocation

What you should do RIGHT NOW

If you found this update useful, it would mean a lot to me if you would help us get the word out and share it with your friends and colleagues who participate in the Thrift Savings Plan using the email and/or social sharing buttons below.

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