Phew! Sorry to have been away for so long. For those of you who were anxiously awaiting the baby’s arrival, we had a beautiful baby boy at the beginning of June. He is perfect in every way and everything is going very smoothly.
Everyone told me that having a baby would eat up every little bit of time, but until I was living it I didn’t understand how quickly the thousand little things you have to do each day add up to every waking moment.
I have no idea how so many people successfully pull off this parenting thing – I can’t even imagine what this would be like if I were a single parent, or my wife was going back to work, or we had twins, or money was tight, or we didn’t have health insurance, or all the other issues which could make this so much more stressful. But I do have a healthy new-found respect for all the people in my life who have been accomplishing this with much less fuss and fanfare than I have been doing it with.
I have already opened a 529 Plan for the baby and he has more money at three months than I did at 25 years. I have started drafting a post on why I selected the plan I did which I will try to finish up in the coming weeks.
For those of you who were distressed by the lack of blog posts over the past couple of months, I do promise that no matter what else is going on in life, I am still spending a lot of time looking at the economy and the markets (I get a lot of reading done during 2am feedings). And if there is ever anything which I think is worth getting excited about, I will dash off a quick post.
Back to why we are here
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.
It has been an eventful few months since the last time I wrote, but nothing has happened to change my overall outlook on the market. I have been disappointed by the performance of the I Fund, but as I will discuss below I am still optimistic about its prospects over the next six to twelve months as it has a lot more upside from a valuation perspective than the other stock funds do. (Please feel free to disagree, but not with any argument which is backward facing.)
Thrift Savings Plan Fund Returns
Year-to-date returns (through 09/11/2018) for the C and S funds are excellent for this point in the year and on pace for well above average gains. Hopefully we will get that Fall rally again this year to keep those moving in the right direction and the I Fund will slingshot its way back to respectability:
- TSP C Fund: 9.46%
- TSP S Fund: 11.78%
- TSP I Fund: -4.40%
- TSP F Fund: -1.42%
- TSP G Fund: 1.97%
The Stupid I Fund
I take a bit of solace from the fact that the divergence in the performance of the US stock market compared to international markets is completely unprecedented. They have never been as out of step as they have been over the past year before. This has never happened before. Ever.
Typically, the US and developed markets move in the same direction over any meaningful amount of time, with the difference in performance ranging from almost nothing to double digit percentiles. That has always been the art for me – trying to divine which will outperform the other (and choosing US equities as the default when nothing nudges the decision in one direction or the other). But they do always move in the same direction.
Except recently. Right when I stuck half of my TSP balance into the I Fund. Nuts.
So what does that mean going forward? I certainly understand that for some folks who are in the I Fund right now there is a temptation to move away from the I Fund after watching it be basically flat or even down a bit while the C Fund and S Fund are performing well. And since I really and truly don’t want to come across as giving advice on what fund other people should pick, I won’t tell anyone that’s a bad idea.
But I will tell you that in investing I look for divergences like this and invest to take advance of the inevitable convergence to follow. When valuations are way outside their historical norms, they will come back. I believe that when the US and developed markets go in opposite directions, they must eventually come back together. And the further apart they get before that happens, the greater the difference in performance as they snap back. Right now the P/E ratio of the C Fund is 24.2, while the P/E ratio of the I Fund is 15 (I use that just as the simplest possible metric for comparison, there are, of course, a lot of different ways to compare the markets including variations on the P/E ratio as well as the P/E divided by growth (PEG) ratio. All of those point towards the US being over/highly valued and developed markets being undervalued at this point.)
So I am sticking with the I Fund as 50% of my allocation. Over the next six to twelve months, I believe it will in all likelihood outperform the US stock funds. That opinion is based more on valuation than relative economic strength, but I would also note that Europe appears to be earlier in its business cycle than the US, and if that is the case it also has further to run.
The I Fund might very well not outperform the US market. I thought the same thing a year ago, and look how that turned out. But I am an experienced enough investor to know (a) that everyone is wrong regularly, so I don’t lose a minute of sleep over it, and (b) that I am right more often than I am wrong, and that these decisions are how I got to where I am.
August’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.)
Employment numbers: Total non-farm payroll employment increased by 201,000 in August, and the unemployment rate was unchanged at 3.9 percent. Job gains occurred in professional and business services, health care, wholesale trade, transportation and warehousing, and mining. I obtain this data from the Bureau of Labor Statistics.
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 significant improvements in the rate are unlikely. So we focus much more on wage growth at this stage in the business cycle. Over the year, average hourly earnings have increased by 77 cents, or 2.9 percent. That’s quite reasonable and shows the economy is continuing to grow.
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 August PMI reading of 61.3 is a very strong number:
Manufacturing expanded in August as the PMI registered 61.3 percent, an increase of 3.2 percentage points from the July reading of 58.1 percent. The PMI reached its highest level since May 2004, when it registered 61.4 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 43.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the August PMI indicates growth for the 112th consecutive month in the overall economy and the 24th straight month of growth in the manufacturing sector. The past relationship between the PMI and the overall economy indicates that the PMI for August (61.3 percent) corresponds to a 5.6-percent increase in real gross domestic product (GDP) on an annualized basis.
The last twelve months:
Yield spreads: The yield curve has gotten a lot of press lately as it has flattened, most of it very simplistic and in the sky-is-falling vein. The big thing is to note that the yield curve is flat, not inverted (inverted is when long-term interest rates are lower than short-term rates) – and an inverted curve is the traditional predictor of recession, not a flat curve. When and if the curve does invert, the rule of thumb is that a recession will begin about a year later.
I get this information from the Cleveland Fed, who has this to say:
The dog days of August continued the yield curve’s trend of the last several months, with it twisting still flatter, as short rates moved up and long rates moved down. The 3-month (constant maturity) Treasury bill rate rose to 2.08 percent (for the week ending August 24), up from July’s 2.00 percent and from June’s 1.94. The 10-year rate (also constant maturity) dropped to 2.83 percent, just down from July’s 2.86 percent, itself down from June’s 2.91 percent. The twist dropped the slope to 75 basis points, down 11 basis points from July’s 86 basis points, which was 11 basis points below June’s 97 basis points.
Despite no change in predicted growth, the flatter yield curve led to an increase in the estimated probability of recession. 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 August at 18.8 percent, up from the July number of 16.9 percent, and up from June’s 15.2 percent as well. So the yield curve is still optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.
Of course, it might not be advisable to take these numbers quite so literally, for two reasons. First, this probability is itself subject to error, as is the case with all statistical estimates. Second, other researchers have postulated that the underlying determinants of the yield spread today are materially different from the determinants that generated yield spreads during prior decades.
Possibility of recession calculated from the yield curve:
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) hasn’t been updated by the Federal Reserve since July, but the growth trend has continued this year, even if it has slowed a bit:
Money Supply M2 in the United States increased to 14147.30 USD Billion in July from 14112.30 USD Billion in June of 2018.
All of the above data leads me to believe that we remain in the Mid/Growth/Performing stage of the US business cycle and so I am going to continue to allocate the other 50% of my balances and contributions to the C Fund. The other 50%, of course, is allocated to the I Fund. If I were not currently in the I Fund, my allocation would be 100% C Fund.
The Thing I Really Like This Month
My financial life is spread out over a bunch of different accounts – I have ten accounts just for investments and banking. It always bugged me that I couldn’t immediately see a snapshot of everything in one place by clicking on an app, but I wasn’t doing that because either the decent apps couldn’t access the TSP or I didn’t trust the company which put the app out.
Over the past few months I researched and started using Personal Capital to do that. Their app is free, very simple to use, and I trust the company with my information. Their desktop site also has a ton of different tools for looking at your investments and doing research which I haven’t had time to play with yet, as well as tracking a lot of other financial information that I’m not particularly interested in, but which some other folks will love (budgets, spending and cash flow, for example).
Personal Capital isn’t doing all of this as a public service, of course. They are hoping that you will start out using their free app and information and then move on to having them manage your money. But I have been using it for about six months and there is zero pressure to do so. When you sign up, you do have to schedule a call with an advisor as part of the process, but when you get the email confirming the call you can just cancel it with a response that you are just exploring their free offerings. I did do the call just out of curiosity and had a nice chat with a smart guy in San Francisco who told me it was pretty clear I didn’t need any help just now, but pointed me towards some tools on their website and encouraged me to talk to him again as I got closer to making financial decisions around retirement.
The Next Update
I promise I won’t go as long between posts again. I will shoot to get the next one out in early November, after all the October numbers are 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 occasionally post items of interest which I stumble across for investors, Feds and the military: @TSPallocation
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