THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.
Well, that was fun. When I started writing this post the market was in turmoil, but this has been a very quick correction and we have already recovered 70% or more of the losses we saw. As I will discuss below, despite all the angst I know that created for some readers, it was all very normal and healthy for the market and I didn’t lose an instant of sleep.
First up, I want to again thank the folks who donated to support the site since my last update. I have big plans to update and expand the website in 2018 and those donations will make that a lot easier.
Bottom line up front: I will be sticking with an allocation of 50% TSP C Fund and 50% TSP I Fund in both my existing balances and new contributions this month.
Thrift Savings Plan Fund Returns
Despite all the excitement, we are really doing very well. TSP Funds year-to-date (through 02/16/2018):
- TSP C Fund: 2.45%
- TSP S Fund: 1.14%
- TSP I Fund: 1.34%
- TSP F Fund: -2.11%
- TSP G Fund: 0.32%
Correction? What correction?
If someone was traveling or otherwise distracted at the end of January, they could be excused for not noticing that we saw a correction at all. Last week, in particular, helped us catch up quickly as we had the strongest week in five years and the S&P 500 (TSP C Fund) climbed 4.3%.
Corrections are common, and normal, and healthy
The S&P 500 has undergone 36 corrections of 10% or more since 1950 (that includes some rounding). That’s pretty much one every two years. If you go back to 1928, it’s closer to one a year.
You may not even remember at this point because the market recovered so quickly, but stocks fell more than 12% in the summer of 2015 and 13% in early-2016.
But the media said this one was huge!
Corrections like this are the financial media’s Super Bowl – ratings soar and advertising dollars flow. That is especially important these days with ratings lost to cable news coverage of whichever poor lost soul the Donald slept with while married to Melania. So it is in their interest to hype the story as much as possible. That led to breaking news splash screens proclaiming “DOW’s biggest ever one day drop!” and the like. That particular line is both completely true and misleading to the point of being meaningless. First, the DOW is a dumb index to follow and I don’t even have it displayed on my stock app (it is price weighted rather than market cap weighted and consists of only 30 stocks). And second, while it is true that this was the largest point drop ever for the DOW, as a percentage drop it wasn’t noteworthy at all.
What caused the correction?
We all really, really want to have an explanation for corrections because then we can tell ourselves we will be able to spot similar circumstances in the future and try to avoid the next pull back. But most of the time the only reason stocks fall is because they can’t simply keep going up forever.
Look, there was stuff going on which might give an excuse for some traders to pull out of the market. The US economy is heating up (the January jobs report showed more jobs were added to the economy than expected and wage growth was also stronger than anticipated). Strong growth could push inflation higher and that could lead to the Federal Reserve hiking interest rates more aggressively.
And higher interest rates mean bond yields increase in value, making it more likely investors will move out of volatile stocks and into bonds for a safer, near-guaranteed return.
Stock valuations were also pretty high. The S&P 500’s price-to-earnings ratio, a common measure to determine if the market is cheap or expensive, was at 18.7 times the S&P 500’s expected earnings at the January market peak. It fell to about 16 at the bottom of the correction. It has bounced since then to above 17, but is now trading a little closer to its long-term average P/E ratio of around 15.
But really, the market dropped because the market occasionally drops. And there was nothing we could do to predict when that was going to happen with enough specificity to benefit from it.
I absolutely told you that the market was due for a correction back in my Look Forward at TSP Investing in 2018. And I also told you that I didn’t have any idea when in the year that might happen, and that if I pulled out of the market whenever we were “due” for a correction, I would miss out of most of the market’s gains.
Where does the market go from here?
Long term, the overall economic picture looks very good for 2018, and probably 2019 as well, with absolutely no indication that a recession is likely.
There have been 11 corrections during non-recession periods since 1976. Of those 11 corrections, 1987 was the only time the market wound up down more than 20% and entered bear market territory. That’s not likely to be the scenario this time, not with GDP growth around 2.5% and the unemployment rate at 4.1%.
More of a dip? Possibly.
Is there a way to profit from corrections?
This is a TSP allocation website, so no, I don’t think there is a way to profit from these routine corrections in your TSP. I’ve been studying investing for 35 years, and am absolutely convinced that trying to time the market in the short-term is impossible and that selling in anticipation of a correction is a guaranteed money loser over time. Every study shows that investors are better off staying fully invested in a bull market.
Outside the TSP and if you have some cash on hand, corrections certainly offer a buying opportunity. Lots of big-name stocks are in bear market territory – if you have been looking for a good point to buy Apple or Visa or dozens of other major company stocks, they are down more than 15% from their highs right now.
January’s Economic Numbers:
In this section I discuss the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance. (These indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle.)
Total nonfarm payroll employment increased by 200,000 in January, and the unemployment rate was unchanged at 4.1 percent. Employment continued to trend up in construction, food services and drinking places, health care, and manufacturing.
Taking a look at the unemployment rate over the course of the year, you can clearly see that we are at the natural rate of unemployment and further improvements in the rate are unlikely. So we focus much more on wage growth at this stage in the business cycle.
Those wage gains exceed expectations last month. In January, average hourly earnings for all employees on private nonfarm payrolls rose by 9 cents to $26.74, following an 11-cent gain in December. Over the year, average hourly earnings have risen by 75 cents, or 2.9 percent. Average hourly earnings of private-sector production and nonsupervisory employees increased by 3 cents to $22.34.
I obtain this data from the Bureau of Labor Statistics.
Purchasing Managers’ Index (PMI):
As usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates growth in manufacturing and anything over 43.2 indicates an expansion of the overall economy. The January PMI reading of 59.1 is a very strong number:
Manufacturing expanded in January as the PMI registered 59.1 percent, a decrease of 0.2 percentage point from the seasonally adjusted December reading of 59.3 percent. This indicates growth in manufacturing for the 17th consecutive month at strong levels led by continued expansion in new order and production activity, with employment growing at a slower rate and supplier deliveries continuing to struggle.
A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting. A PMI above 43.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the January PMI indicates growth for the 105th consecutive month in the overall economy and the 17th straight month of growth in the manufacturing sector.
The past relationship between the PMI and the overall economy indicates that the average PMI for January (59.1 percent) corresponds to a 4.9 percent increase in real gross domestic product (GDP) on an annualized basis.
The last twelve months:
Yield spreads: The yield curve has made a definite move to the upside and gotten steeper in the process. I get this information from the Cleveland Fed, who had this to say:
Using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.4 percentage rate, just up from the December number of 1.3 percent and back to the November number of 1.4 percent.
Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate the expected chance of the economy being in a recession next January at 12.9 percent, down from December’s 14.2 percent and November’s 14.3 percent. So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.
Money supply growth rate: 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) decreased in January for the first time since I have been writing this blog.
Money Supply M2 in the United States decreased to 13838.30 USD Billion in January from 13844.50 USD Billion in December of 2017.
That is an interesting development, but easily explained by the Federal Reserve’s policy changes as they end years of easy money. If this had happened naturally, it would be cause for concern and would bear close watching. Because the drop has been intentionally created by the Fed, this indicator will not be meaningful for my purposes until the policy changes have run their course.
All of the above data leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle (although I do think we are moving later in that stage) and so I am going to continue to allocate my balances and contributions 50% to the C Fund and 50% to the I Fund.
Bitcoin and other Cryptocurrencies
Speaking of gambling, just a super quick update on my experiment in cryptocurrencies which I wrote about at the beginning of the year. It has been an exciting couple of months, with the market down much more than it has been up. I have been a little frustrated that either there are no norms, or I just haven’t figured out the norms yet, so I haven’t been in a position to trade the big swings in the chart below. So my positions are still exactly where I was at the beginning of the year. Holding has worked out okay so far – I’m up about 25% on my initial (tiny) investment.
Once again, Bitcoin and other cryptos are not investments in my opinion. I am playing with them for fun with a very small amount of money to see if I can’t make a few gains riding the wave created by other people who insist on making bad choices.
This month’s book is The Elements of Investing by Burton G. Malkiel, author of A Random Walk Down Wall Street, and Charles D. Ellis, author of Winning the Loser’s Game. I am only part way through, but it appears to include all the main topics from their best selling books, and adds in a lot of personal finance and saving advice. It is a very good book so far, geared more towards the beginning to intermediate investor.
The Next Update
Quick note: there is an excellent chance that as we are already getting towards the end of February, I won’t write an update in March and the next one will be out in early April after all the economic numbers roll 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 stumble across for investors, Feds and the military a few times a week at: @TSPallocation
What’s in it for me?
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