TSP Smart: It was all Fun and Gains until Inflation showed up to the Party.

I read forums and discussions on TSP funds to understand the basic investor thinking. There are many strong opinions that one should never sell. Hold, the market always bounces back.

And you know what, in the last 13 years they have been right. They don’t know why, but they have been correct.

What the above graph shows is the high correlation of the US stock market to central bank printing operations with Europe and the US Federal Reserve playing tag team. Until 2020 only one of the two central banks were engaged in significant QE at the same time. Meaning buying financial assets with money printed out of thin air.

The problem with pumping the stock market up (via the bond market) was they failed to pump up the US economy over standard growth levels that was necessary to support these prices in the future. Meaning corporate cash flow is not there to offer much return on current prices being paid.

A more simple picture emerges when we plot what the SP500 would be if the price level equaled its historic average of 1x revenue, but that would be too ugly to post so I plotted the SP500 price at 1.4 times its revenue level. See the jagged red line below.

The central bank’s buying greatly affected the marginal buying of stocks that sets price. BTW, passive investors have no impact on price only the active buyers and sellers of marginal shares.

We also know that corporations have borrowed and burned significant cash on buying their own shares on the open markets. This too temporarily creates artificial demand and effects price significantly more than it affects earnings or revenue per share.

So the question has not been if, but when the market will reset its price level back to something reasonable that offers a descent FUTURE return in terms of earnings/revenue/cash flow from operations.

Long term future returns today are at their lowest level in history.

That upward trend in the market has made a lot of people feel wealthy on paper. It is only wealth if it can be translated into future cash flow in retirement. Riding the market back down when prices reset will wipe out a lot of paper wealth.

Make sure you understand what is driving the price of the stock market. I see it mainly as flows in and out of stocks in aggregate influenced by:

  1. Central Bank Buying
  2. Corporate Buybacks
  3. Sentiment (allocation levels)

All three of these are reinforce each other. In both directions!

The Central banks now have a problem.

It was all fun and gains until inflation showed up to the party. The central bank’s problem is do they let inflation destroy money or do they attempt to slow inflation by tightening monetary policy.

First they had to admit they had an inflation problem… they just did. They just signaled they are switching to fighting inflation. In order to do so, they have to stop propping the stock market up.

2022 will be a challenging year for investors.

Invest Smart become a member today,

Michael Bond


TSP Smart & Vanguard Smart Investor serves serious and reluctant investors



Categories: Perspectives