The bottom line: It sucks looking forward.

The equity funds are back to the top of their price channel after the largest Federal Reserve intervention yet. The TSP G fund is paying 0.7% to 0.8% interest annualized currently. The TSP F fund has a SEC yield of 1.22% and falling.

The Fed/Treasury intervention does not change long-term stock market returns which are dismal. Sorry, low profit growth and high debt equals no returns over the coming decade.

Retirement investors continue to bet on more Fed interventions or are just completely oblivious of what has conspired.

Bonds

Before we go into future returns, please consider the rest of the world’s bond funds.

Currently Vanguard’s World (minus US) bond fund has a SEC yield of 0.24%. That leaves room for a 2.5% capital gain before hitting zero yield. And when they hit zero yield, what you get is… zero yield.

Central banks: “You’ll get nothing and like it.”

Just to understand why the international bond fund’s yield is so low, you need to understand that $17 trillion in global government bonds now have negative yields (you pay to hold this stuff).

What sucker would buy negative yielding bonds? Passive international bond fund holders. Note: TSP does not invest in international bonds. But it highlights a point.

If you hold the TSP F fund today, you are buying the aggregate US bond market (investment grade). Treasuries are mostly under 1% yield now, but inflation is higher than that so your real yield is negative. Some think this is a great reason to buy stocks today, but I think 1% will beat the return on the SP500 the next 10 years.

The past returns of the TSP F fund look good. Last year it was up 6% but mostly on capital gains as they pushed interest rates to the floor. They do not want to go negative in the US Treasuries and our coming federal budget needs are massive ($3 trillion+ a year). The point is, capital gains have already been squeezed out of US bonds. So you get yield – currently 1.22% and probably dropping nearer to 1% soon.

1% comes with some default risk, but it does not cover inflation.

If they allowed interest rates to rise again, the policy makers know the global financial system would implode. So I will only mention that if the F funds yield moved up to equal inflation the fund would sustain a 5% capital gains loss wiping out 3 years of yield.

Ask your local pension fund and brokerage marketing department what they expect for their retirement portfolio return going forward. They will tell you something near 7% annualized over the next decade. Not going to happen. It can’t.

Stocks

Yeah, I know what the stock market has done. I know why too. But I will let you in on a secret. When profits drop like a rock and prices go up, it is a valuation expansion and not a fundamentals-driven expansion which is sustainable. And so new extremes in valuations keep getting taken out… until they don’t and we get an extreme reset.

Valuation is not a timing indicator. But it is a solid long-term return predictor. And today, expect negative returns 10-12 years out including dividends.

Negative.

But not some slow straight line of flat or negative returns – It does not work that way. There will be another cascading event. The Fed will push back – print, print, print. But if they could hold the bubble at current levels then in 12 years maybe real corporate cash flow would catch up to current prices. Still no gains.

But it has never worked that way before.

Either way, this means the 60/40 portfolio is dead (60% stock / 40% bonds). It only worked because we have been in a long 40 year bond bull market as yields dropped from over 13% to under 1%. The bull market is over or we go negative interest rates. Then what do you get?

The Lifecycle portfolios are in the same boat. They are buy and hold. Robo investment advice too. They are all buy and hold based on your age and stupid questions about your risk tolerance. They don’t care about valuations and real risk, they just keep you invested in fee earning funds.

In other words, those bond funds are not going to rise to offset any stock market losses in the next bear market (cyclical and secular). And stock prices have a whole lot of resetting to do to get back to a descent future return above 7%.

Drivers

Those who have followed me awhile know I have said the stock market is completely detached from the US economy and real corporate fundamentals. I have listed the ways:

1. Corporations spending cash flow buying back their own stock on the open market
2. And borrowing money to buy back their own stock on the open market
3. Reporting different earnings to investors than to the SEC
4. Federal Reserve printing trillions to buy financial assets that rotate into stocks
5. Lower taxes on the investor class flows into the financial market not the economy
6. Tech companies obtain 70% of the revenue overseas but sit on the SP500
7. Under-reported inflation overstates GDP and wage growth
8. The monopolization of our economy which may reserve soon

On the buybacks.

They temporarily distort the “demand” for stocks in the supply/demand curve. Yet the reduction of stock outstanding from buybacks during an entire market cycle would only boost fundamental values by 10%. The demand from buybacks overwhelms selling and drives price up, but the demand disappears when they stop buybacks in recessions or become too indebted. Individual company stock prices often crash at that point.

US corporations had the highest debt ratios prior to COVID and doubled down since COIVD. It is not pretty. Zombie companies now make up 20% of the US stock market meaning they can not cover debt payments with earnings. Other US debt trouble has been covered up by forbearance which allows bond funds to not report lack of payments as defaults. This will end soon.

Recent Market Action

I see the massive ups and downs the last couple of years as a tug-o-war between free market price discovery (down) and the Federal Reserve/Treasury interventions (up). During the last year the “political” in the political-economy became obvious to those who watch closely. How it plays out going forward is undetermined. It depends on who Biden places in key roles. But nothing changes the underlying situation in the economy and market.

The Fed has only one tool for the financial markets – print money out-of-thin-air to buy financial assets. They have used most of the $20 trillion on the financial markets with little to negative effect on the real economy. They could use it to support the real economy, but that would take Congress.

While detached, the economy still drives sentiment – second wave effect coming folks. Toilet paper is selling out again. Economic activity is slowing again.

I thought I would throw this out to just give you a feel for companies balance sheets and book value. While many companies still show assets exceeding liabilities, most “assets” today are “intangible assets” with made-up values. Some are legit. Some.

90% of reported assets in the SP500 are “intangible” assets. Remember that when looking at book value valuation models. Remember banks use asset-to-debt ratios when making loan decisions.

Here is the most valuable stock in the world today – Apple. I wonder what drove its price sky high when its revenue has been flat since 2018?

Oh yeah, the central banks dumped $4 trillion in the financial markets since March.

To give you perspective those $1200 stimulus checks sent out to every American only added up to $350 billion total. Note: Every $1 of unemployment payment creates $1.64 in growth in the economy. $1 in Apple stock price going up creates $0 of new economic growth.

More checks to the people in need would provide a huge bang for the buck. Bailing out corporations will not. Restructuring their finances would be better. But the investor class would not like that – they prefer cutting jobs and defaulting on pensions.

It’s all fun and money printing until something breaks. or everything breaks.

One last comment. This money printing game only started after the last financial crisis and the markets became addicted to it. There is no easy way out. Market valuations have to reset somehow. They can force interest rates to stay low but pension funds and savers will lose everything if consumer inflation spikes. The economy will not benefit from the money printing unless wages rise faster and the policy makers have successfully engineered the opposite for 40 years.

Invest safe, invest smart.

Survive until the next bull market.

Michael Bond

Read our TSP 101 info if any of this is new to you: Best TSP Allocation Strategy. I will update in in 2021 as we gain clarity on the next administration.

TSP Smart & Vanguard Smart Investor serves serious and reluctant investors

Categories: Perspectives