If you held the TSP I fund since the beginning of 2008 just after the last bull market peak would have been rewarded with a total return of 4.8% or less than 1% annualized.  The TSP I fund turned down in the summer of 2014 diverging further from the US equity funds as the global economy slowed.  The I fund did outperform the US equity funds in January of this year as the US funds traded sideways and the European Central Bank (ECB) announced the launch of a Euro version of Quantitative Easing (QE) to begin in mid-March.  In February, the I fund tracked the TSP C and S fund returns and showed no relative advantage.

Relative Performance Since 2008

Some strategist are urging European CEOs to borrow at these cheap rates and buy back shares like US companies have been doing at a rate 10 times higher than European companies.  This has no benefit to the economy.  Excess cash should be available for capital investment, shoring up pension plans, increased wages, and dividends;  or buying during a bear market when stock prices become undervalued and return on investment is higher.   One has to question why central banks are loading up on debt if it merely allows financial engineering and little is transmitted to real the economy.

Articles have been appearing in the media about how Europe looks more attractive from a valuation point of view than the US.  With the current US market valuations only exceeded in the 2000 stock market bubble by many measures, it does not take much to make this argument.  The fact that the S&P 500 companies forward earnings forecast have turned negative while the market surged higher has decreased expected long term returns for US equities below 2% by highly correlated historical valuation methods.  But this does not mean the I fund is necessarily a good value play.

The collapse in prices of global commodities points to the slow down in the global economy that is beginning to appear in the economic reports.  One of the reasons the TSP I fund has underperformed is due to the weaker economic recovery of its underlying countries.  Let’s take a look at the current economic picture (always lagging) of the top 80% market capitalization of the I fund countries:

% I Fund (2013)         GDP growth        Interest Rates      Debt/GDP

22%  UK                                 2.7%                      0.50%                      91%

21% Japan                          -0.5%                      0.00%                    227%

10% France                        0.2%                       0.05%                     92%

10% Germany                   1.6%                        0.05%                    77%

9% Switzerland              1.9%                      -0.75%                     35%

8% Australia                   2.7%                        2.25%                     29%

The weighted average GDP growth for the I fund countries is 1.1% compared to 2.2% US GDP in the 4th Quarter recently revised down from 2.6% and over 5% in the quarter prior.  For comparison, the US Debt to GDP is now 102% with a Fed Fund rate of 0.25%.

Twenty-one countries have lowered their interest rates in 2015 and some rates are now negative.  Not only does this signal a lack of confidence in the global economy, many consider it a currency war.  The last global currency war ended by the start of WWII since once it starts it is hard to end.  If the Fed diverges from other central banks and begins raising rates in June, more funds will flow into the US and the dollar should continue to rally.  One of the I fund’s risk is currency risk and a rallying dollar subtracts from the I funds returns.  With the I fund you are investing in lower economic growth, political risk, Japan’s debt problem, and currency risk from a rallying dollar.

You also receive a healthy dose of all of these risks with the TSP C fund since a third of its revenue are non-US revenue and 13% is from the European region.  The TSP S fund has the lowest exposure to non-US revenue.  It is hard to predict if ECB QE will continue to lift the European stock market since they will have difficulty executing it in an effective way.   Both ECB QE and predictions of when the Fed will start raising interest rates may be red herrings as the economy decelerates and earnings fall.

It does appear the Fed may be finally coming around to the idea that the economy is not accelerating but decelerating.  They may also be realizing they initiated a currency war and they have no monetary leverage with rates at 0.25% if the economy heads into a recession.  Unfortunately, US corporations have spent all their earnings on stock buy-backs and dividends and not capital investment for future growth with their windfall under the zero rate policy.  The average age of fixed assets reached 22 years in 2013, the highest level since 1956 according to the Commerce Department.

The stock market can diverge and stay detached from a slowing economy for many months.  There is no rule that says valuations can not exceed the stock market bubble of 2000.  If they do it will be on the back of extreme monetary policy.   There is no rule that interest rates can not go negative in the US theoretically boosting the I fund  another 10% and taking the yield to zero.   Get it…zero yield.  Goldman Sacs recently warned the fixed income market is struggling with valuation measures as we approach zero and there is risk of wide swings.   We are in uncharted territory.

Categories: Perspectives