TSP Funds: Situational Awareness

Excerpt from TSP Smart’s 11 March 2021 Full Access Member update:

Let’s start with a mental exercise to wrap our heads around the current situation. 

What happens if we allow the financial markets to return to normalized free market pricing:

  1. 10-year Treasury yields would be running 4-5% based on the last 10 years of nominal GDP growth.
  2. 30-year mortgages would come with 6% + rates.  
  3. Home prices would need to fall 30% to make entry monthly home payments stay level. 
  4. The stock market would be 50% to 80% lower as we will see… 
  5. 10-year bond prices would drop 30% in value if interest rates surged back to 4.5% 
  6. The 60/40 allocation model would get slaughtered.  Lifecycle funds too. 
  7. The TSP G fund would earn 5-6% annually. 
  8. The TSP F fund would have capital losses of 21% on its way to earning 5-6% yield. 
  9. Money market funds would pay at least 2-3% in FDIC accounts 
  10. The global financial system would melt down which explains why the central banks should never have flown us into this boxed canyon of money printing and below inflation interest rates. 

We always need to start with this first chart before having a long conversation – we need a yardstick to understand what we are paying for in the stock market. And equally important is knowing that the higher the valuation, the lower the future returns on your investments HAS TO BE.  Just obviously not in the short-term.

We are paying $3 dollars for every $1 dollar of revenue of the SP500 companies where the historical average was only $1 per $1 of revenue prior to 1995.  And no, low interest rates do not justify this.

To be clear, you are paying 300% more than the historical mean. 99.99% of all past valuations were lower than today 11 March 2021 based on price to revenue. Or the market could lose 66% of its value and be considered normalized in terms of valuations.

The “bubble”  during the 2000 tech bubble was limited to about 15% of the US stocks by valuation measures (the rest were at normal bull market top prices) … the tech stocks were just sky high in valuations in 2000 and these tech giants were still working off those valuations during the 2003 – 2007 bull market which is why valuations remained flat overall.

Earnings are easily manipulated and tax code changes the definition of profits.  So revenue is a more stable yardstick to measure prices.

Note the 2003 bear market was the most expensive bear market bottom in history and it took another bear market to get back to the mean valuation levels under $1.  The all-time historical low was below 33 cents per $1 of revenue.

The current bull market in stocks is part of a larger bubble – a credit bubble enabled by the central banks.  The Federal Reserve has encouraged a debt bubble by manipulating interest rates lower (under the auspices of helping the economy).

But instead, US companies leveraged up their corporate balance sheets (corporate debt bubble), and hedge funds leveraged up to buy those leveraged stocks and bonds, and today investors margin debt is at a record.  Who knows what leverage is hiding on paper in the derivatives market.

Corporate buybacks accelerated the leverage by increasing corporate borrowing for stock buybacks or just simply using corporate cash to buy back stocks and thus reducing the asset side of the balance sheet. Leveraging increase returns, but it amplifies losses on the way down. Bubble mechanics have never worked in reverse.

Those two sharp reversals in the stock market in 2018/19 & 2020 show us how unstable the leveraged system is today.  Credit is the most unstable of all forms of money. With corporations loading up on another $1 Trillion in debt the system is even more unstable today and on monetary life support once again.

The 33% plunge in the SP500 index in early 2020 was halted by more debt and money printing by the Federal Reserve.  During the drop, valuations of the SP500 only made it half way to its long-term mean and if you look closely the ratio only reached the top level of the 2007 bull market level!  

Note: Global Liquidity equals global money printing to buy financial assets by our activist central banks.  This next slide shows how a global economy can crash and the stock market can surge.  All the stimulus early on went to the financial markets to save over-leveraged hedge funds from themselves… Some where former Federal Reserve governors are getting paid handsomely for their “advice”.

There is much more in our 11 March update, but I want everyone to know the risk in the market today and how we got to this point. It is not profits or the economy, but serial attempts to usurp the free markets which got us to this point.

It’s getting interesting. And dangerous.

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Categories: Perspectives