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This month I will talk about the impending correction (I learned teaser lines like that from the internet), my views on the market’s overall valuation and moves by the Federal Reserve, and of course I will run through the economic indicators.
Thanks for all the notes from folks eagerly awaiting a fresh update and asking if I was okay. It was good to feel missed. The “Look Forward at TSP Investing in 2017” covered the January update, and February was so short it just didn’t seem worth the trouble.
Thrift Savings Plan Fund Returns
The market flattened out over the last month, but has still had a pretty fantastic run since Election Day. The TSP Funds for 2017 year to date (through 03/15):
- TSP C Fund: 7.03%
- TSP S Fund: 4.61%
- TSP I Fund: 6.44%
- TSP F Fund: 0.19%
- TSP G Fund: 0.48%
And here is the TSP C Fund chart since the election:
The Impending Correction
In my New Year’s predictions each January I write this:
As at the beginning of every year, I will confidently predict we will see four or five 5% corrections, and probably a 10% correction at some point (because that happens pretty much every year). With history as a guide, I am convinced the timing of those corrections isn’t predictable, and that the market will recover and move higher in each case within a matter of weeks.
It’s going to come, it’s just a matter of when. You have to go way back into 2016 to find a 5% correction, so from a statistical standpoint we are way overdue.
The hard part is not falling into the trap of believing that because we are almost a quarter of the way through 2017 and it hasn’t happened yet, it must be imminent. The truth is, it could happen tomorrow or it could happen in another 4 months after the market has run up another 10%.
I am a dispassionate, relatively clever (I must be, I have a blog) investor. But I fall into that trap of not wanting to buy at market highs as much as anyone else. On January 1st I made a non-deductible contribution to a traditional IRA, then promptly converted it into a Roth IRA (the “backdoor Roth” maneuver). So I had $5500 sitting there in cash. My plan was to buy a low-cost, vanilla S&P 500 ETF with that money. But the market was so high, and it had been so long since we had seen a correction – surely the market would hiccup and I would have an opportunity to buy in at a lower price if I just waited a week or so, right?
Two months later, the S&P 500 is up 7% and I still have $5500 sitting in cash. So that’s about $385 I missed out on – not a lot of money, but still dumb. What I should have done if I really wanted to make sure I didn’t buy just before a downturn was average in – I should have bought in at $1000/week until it was all invested (or whatever amount I was comfortable with). Part of the problem is that I didn’t wake up every morning and think about whether or not I was doing the right thing. Instead I occasionally remembered that the money was sitting there, kicked myself, and went back to reading Twitter. Which goes to show that I needed a plan and I needed to stick to it. “Waiting for the market” wasn’t a plan.
Is the Market in a Bubble?
The financial media has turned into reality television, and reality TV needs conflict to keep viewers watching. The theme this month seems to be trotting talking heads out who will say the market is overvalued to the point of being in a bubble and we will see a huge collapse when that bubble bursts. That’s an easy one, because when it doesn’t happen they can double down and talk about how the market has gotten even bubblier and the impending crash is going to be that much worse.
I think the market is expensive right now, but certainly not in bubble territory. When we are in a bubble, stock valuations aren’t based on anything except momentum. Right now when you look at where the Price/Earnings ratio is of the S&P 500 (the TSP C Fund) calculated with estimated earnings per share for 2017, you get a number just a shade over 18. That’s above average (average is 15.64), but not even close to bubble territory.
What did the Fed’s move this week mean?
The Federal Reserve was in the news a lot this week as they met and decided to increase interest rates. The Fed also indicated that they intend to increase rates again several more times this year. What does that really mean to us?
The big takeaway is that this high-powered group of economists believes the US economy is doing so well that they have to tap the brakes and keep it from overheating. When rates go up, borrowing gets more expensive for both businesses and consumers who respond by spending less, so this action is intended to slow down and smooth out growth.
And of course, a strong economy is a good sign for stock market investors, because the only thing we are really worried about at the end of the day is the possibility of a recession. If the Fed thought there was any prospect of that happening, they would not be raising rates.
February’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 235,000 in February, and the unemployment rate was little changed at 4.7 percent. I obtain this data from the Bureau of Labor Statistics.
We are in the full employment range, so at this point we also glance at some other numbers like wage growth and number of people entering/reentering the workforce to gauge whether things are still moving in the right direction. But for the most part, this indicator is pretty well played out for this business cycle until we see a lot fewer jobs being created several months in a row.
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 February PMI reading of 57.7 is a very strong number:
Manufacturing expanded in February as the PMI registered 57.7 percent, an increase of 1.7 percentage points from the January reading of 56 percent, indicating growth in manufacturing for the sixth consecutive month, and is the highest reading since August 2014, when the PMI registered 57.9 percent. 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 43.3 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the February PMI indicates growth for the 93rd consecutive month in the overall economy and the sixth 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 through February (56.9 percent) corresponds to a 4.3 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for February (57.7 percent) is annualized, it corresponds to a 4.5 percent increase in real GDP annually.
And here’s a snapshot of the last 12 months:
Yield spreads: The yield curve moved down and became slightly flatter in February. I get this information from the Cleveland Fed, who had this to say:
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 February is 5.63 percent, up from January’s estimate of 5.46 percent and December’s estimate of 4.07 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) increased from December to January. The growth rate is what is meaningful here, and you can see that rate has flattened out since November in the chart below – not a big concern, but something we keep an eye on:
Money Supply M2 in the United States increased to 13270.10 USD Billion in January from 13246.90 USD Billion in December of 2016.
All of which leads me to believe that we remain in the Mid/Growth/Performing stage of the business cycle and so I am going to continue to allocate all of my balances and contributions to the TSP C Fund.
Recommended Reading for TSP Investors
This month’s recommended book is Stocks for the Long Run by Jeremy Siegel. This is a fantastic book by one of the leading teachers in the field and is well worth the investment of time and the price of a couple of cappuccinos.
And my favorite past recommendations are all compiled on this page if you are looking for something else to read:
The Next 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 a few times a week at: @TSPallocation
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