TSP Perspectives: QE to the Rescue?

By Michael Bond on November 23, 2014

Since the October correction, the TSP C and S fund bounced back in lockstep until this last week. The TSP S fund peaked earlier in the week and began a slight slide while the TSP C fund continued to make gains. The TSP I fund only achieved half the bounce the US indexes reflecting the continuing downgrade in reports of economic activity in the rest of the world. But now the media is reporting the ECB may begin a Quantitative Easing (QE) program of their own and China cut interest rates. This created a nice pop in the market, but we will have to wait to see if there is follow through in the markets. Japan announced the expansion of their QE toward the end of October leading to another surge in the Nikki and another push for US stocks.

TSP Funds Performance Since October Bottom

Only the TSP C Fund has established new highs on the last two rallies. The TSP S Fund has traded sideways and the TSP I Fund has been in a steady decline. The recent decline in the TSP F fund may be partially the result of money flowing back into equities after the late October correction in the stock market.

TSP Funds Year-To-Date for 21 Nov 2014

The question remains why the S&P 500 index (TSP C fund) has been outperforming the other indexes and will it continue. I contend all of the equity funds are extremely over-valued, but over-valuations themselves do not lead to declines and are not to be used for market timing. But the small and mid-cap stocks may have gotten further ahead of themselves in terms of valuations than the S&P 500 resulting in the sideways trading we see this year. While the TSP S fund has traded sideways in 2014, it has outperformed the larger caps since the last market peak as seen in the chart below. I also will venture to guess that money is moving from the riskier assets to the less risky — the US large capitalized stocks — as investors take on a more defensive posture with the rising uncertainty in the financial markets.

TSP Funds Since 2007 Market Peak

The Central Banks of the world, led by the US Federal Reserve, are in new territory in terms of monetary policy and QE. The theory has been that QE will result in growing economies that will be able to handle the additional load of new debt they have enabled. But the main street economies continue to limp along with only the financial sphere seeing gains. It is my contention the financial sphere has become disconnected from the economic sphere and the surging stock markets are not an indication of the future of the economy, but merely the result of too much debt-created money sloshing around the world thanks to print-happy central bankers. It also appears that Japan’s latest “surprise” doubling down of QE was more an act of desperation than sound policy since Japan’s GDP declined significantly after the first round of QE, while its disconnected stock market surges higher.

I once commented to a friend that the aggressive monetary policies were leading to financial bubbles flowing into the stock market. He replied that he was happy to see his stocks higher so he believed this to be a good thing. This surprised me a bit since I believe there will be a day of reckoning. So yes higher stock prices are nice, but one has to know when to step aside and preserve ones gains less you give them back in the next bear market or financial crisis. It is the future earnings of the underlying companies that will determine the price of the market in the long run. The earnings of the S&P 500 could continue to rise, but the valuation of those earnings at some point will reflect a more historical valuation — currently well below today’s price.

On the other hand, we find ourselves in the best timeframe for the stock price progression historically in the four year election cycle in all global major stock markets except Japan. Incumbent politicians will welcome both monetary and fiscal policy that will give a boost to the economy and markets this year so they can run on a positive note. We are already seeing the beginning of this with the expansion of QE globally and with some leading Republicans pressing for an increase in Defense Spending. The present market has historical cyclical support even as it breaches the second highest valuation level in the last 100 years. Next year will be a different story.