A quick discussion on the TSP Funds today. A little more than the basics.
There are 3 equity funds and they divide the global stock market up along the following lines:
The TSP C fund which tracks SP500 index that holds 80% of the market value of the total US stock market. The other 3300 small companies listed on the US exchanges make up the other 20% of the US market value – the TSP S fund tracks these stocks. I like to call them the non-sp500 index. There is no overlap in the stocks in these two funds.
The TSP I fund (International) tracks the largest 85% companies listed in the developed world’s exchanges. None of the TSP funds track the emerging markets, but some are trying to get the TSP I fund to add emerging market stocks. So emerging markets and the smallest developed world stocks have been missing from the funds.
When you look at the TSP Lifecycle funds, their allocations to the 3 equity funds are based on the market value of each fund in order to represent the total world stock market minus emerging markets. In other words, Lifecycle and many global funds are geographically diversified based on where the stocks are held.
But guess what? The global sectors are not geographically diversified. The bulk of the global tech companies, revenue and profits sit on the US exchanges and in the SP500 index with very little tech exposure in the International funds.
The outperformance of the US funds is partially explained by the outperformance of five companies (Amazon, Apple, Facebook, Google & Microsoft). The blue line below is the SP500 without these five companies. It works out to a 5% annualized gain over the course of the chart below.
From mid-2015 until mid-2020 the TSP I fund’s annualized return was 0%. Flat. Those five stocks plus the rest of the tech industry is the main difference. The other major factor is that US companies engage in significant buybacks of their own shares on the open market.
The dominate inflow into the US stock market has been buybacks. And again, it is the tech stocks that lead in buybacks.
Tech is not going to move into the International fund. They will stay listed in the US exchanges while drawing 70% of the revenue overseas. This is one of the reasons the US stock market does not seem to match the US economy.
How about profits? Dr. Yardeni breaks it out.
The green line shows the old economy stocks’ Profit Margin on revenue has remained in a range under 12%. Meanwhile the tech sector’s monopolization of their fields has allowed them to continually extract higher profits out of their revenue. This one sector has boosted the overall profit margin of the SP500 from 10% to 12% or by 20%.
When we look at the SP500 price-to-revenue and compare it to historical averages of just under 1.0 and adjust for today’s tech’s dominance, our historical average needs to be adjusted to at least 1.2 or to be conservative 1.4 as seen in this next chart, plotted by the gold line.
The gold line represents what the price of the SP500 would be if it was trading at 1.4 times revenue today.
Based on the Price-to-Sales, the SP500 is running at over 3x revenue. Both previous attempts by the market to reset to more normalized valuations were halted by extreme monetary policy interventions (PPT) which simply creates more instability in the markets.
The pandemic had little impact on the big 5 products and services. The central bank’s flood of printed money filled in some pandemic corporate revenue holes, but much of it just flowed into the financial markets and left us with a very disconnected price structure.
Expect some sort of correction in 2021. The Federal Reserve is even publicly talking about a correction. A big hint.
Bonds
The US aggregate bonds are tracked by the TSP F fund. The weighting of the F fund has come to be dominated by US Treasuries and US Mortgage Backed Securities (MBS) with their implied backing from the US Gov’t. Only about 1/3 of the fund weighting are corporate bonds, with no junk bonds included.
The F funds yield is 1.3% as of mid-May. With significant inflationary pressure on interest rates, more capital losses should be expected over the next year to wipe out that low yield. Another half a percent rise in yields will result in a 3% capital loss for the TSP F fund. I am not a fan of the TSP fund in today’s distorted markets.
The TSP G fund is the safest fund of the bunch and should be used to avoid capital losses in the equity funds. It’s yield is low but it may be the only safe fund out there to come close to keeping up with inflation near term.
The TSP G fund has the full backing of the US Government and Treasury. No FDIC insurance required. It is a virtual fund that provides the extra yield of longer duration Treasuries but with no capital gains or losses when interest rates change.
FDIC insurance was designed to keep people’s money in the bank during crisis so as to not aggravate the banking system with bank runs. The assumption remains that the US government would step in to back the FDIC insurance program in a crisis up to the FDIC limits.
They would have to.
The program only has reserves of 1.3% of all bank deposits. And the wall street banks have forced regulators to allow them to hold their highly speculative trillions in derivatives in FDIC accounts. Corrupt… hell yes.
New Risks
Policy risk could impact the tech sector and the big 5. Anti-monopoly enforcement and limiting the off-shoring corporate taxes are likely. Those profit margins would not be growing if they have competition and breaking them up would provide competition just like AT&T was broken up years ago. This is not a short term risk to profits, but could be to sentiment.
Monetary Policy Risk today is growing from how the Federal Reserve handles the inflation coming this year and probable higher inflation the next few years. If they continue to suppress interest rates while inflation rises, they create both an inflationary bubble loop from driving *real* interest rates deeper into negative territory.
Today the 10-year Treasury has a minus 1% yield after inflation and will jump to minus 2-3% this year if yield is held below 2%. Gold performs well in negative real rate environments. It should because of the amount of money printing required to suppress rates.
Crypto Currency. It is not a stock or bond and not considered money yet so it has NO regulator. That will probably change this year. But it does have the IRS tracking down all the transactions from exchanges to collect taxes on gains.
It is a currency only if people accept it in exchange for goods or services. And while this has grown we also see some companies pulling out of accepting them.
I see them more as a pure speculative play today with prices determined by marginal inflows to marginal outflows. The market caps are not real – there is no claim to any future streams of revenue, just expected price appreciation.
The Colonial Pipeline cyber attack and shutdown ransom was paid for by crypto currency and is the only reason the pipeline is back up. Other companies have been hit. This will drive a hard look at crypto by the gov’t this year. I think crypto will take a hit on the policy changes coming.
Many of you have already read my series on the Best TSP Funds and Allocations which still has good info but rapidly becomes dated in some areas, hence members follow my market commentary on my website.
But I added new piece for members on Seasonal Investing in 2021. It is really a hard look at seasonal investing the last few years which has really diverged from the past. So we need to take into account the effect of the central banks direct interventions into market prices…
… and how to adjust our investment decisions to this current reality. While I have successfully exited the market prior to major drops the last few years I have not been willing to jump back into broken, Fed-supported markets. My new model is designed to speed up the re-entry after market plunges with an objective indicator that has worked well the last few years.
My final bit of advice is to look hard at the sharp market sell offs the last 3 years. This is not normal market top action. It is due to the instability created by monetary policy and the global credit bubble.
While I can almost guarantee that at some point the Federal Reserve will intervene again, there is no guarantee they will be able to navigate the amount of instability in the markets with inflation rising.
Invest safe, invest smart.
Michael Bond
TSP Smart & Vanguard Smart Investor serves serious and reluctant investors
Best TSP Funds and Allocations (free)
Seasonal Investing in 2021 (members)
Become a Member ($75/yr)
Categories: Perspectives