TSP

Companies in the I Fund have an average price-to-earnings ratio of under 14.5 and a sizable 3.4% dividend yield. Meanwhile, companies in the C Fund have an average price-to-earnings ratio of 20.0 along with a smaller dividend yield of just 1.9%. Image: koya979/Shutterstock.com

During the month of March, the G Fund rose by 0.23% and the F Fund rose by over 1.9%, which is a particularly strong month for bonds. The C Fund also rose by a bit over 1.9%, as its strong 3-month rally began to slow and plateau compared to January and February. The S Fund was the worst performer for the month with a decline of about 1%. The I Fund (much cheaper right now than the C Fund) rose by a mild 0.7%.

A Brexit Update

The original date of March 29 for the United Kingdom to formally leave the European Union (aka “Brexit”) has come and gone. It has now been pushed back until April 12.
Nearly two-thirds of the I Fund is invested in Europe, with the United Kingdom alone accounting for a sizable 17% of the assets in the fund.

Citizens of the United Kingdom voted in a 2016 referendum by a narrow 51.9% margin to leave the European Union. The EU includes a variety of shared regulations, trade agreements, and perhaps most controversially, a system of freedom of movement between member countries. Several member countries in the EU also share the Euro currency and European Central Bank, but the United Kingdom has always instead kept its own pound sterling and Bank of England.

As of Friday, UK Prime Minster Theresa May has now attempted three times over a period of several weeks to pass a withdrawal agreement in the UK Parliament, but her proposals were rejected all three times. There are a variety of complicated aspects to plan for when the UK leaves the EU, including updating banking regulations, trade agreements, and border controls.

For example, there is a very big open border between Northern Ireland (part of the UK) and the sovereign Republic of Ireland which cuts across the island of Ireland, and this divide has a substantial amount of violent history associated with it. Since people and goods can move freely between both EU member states, the current border is practically nonexistent. However, if the UK leaves the EU, then this suddenly becomes an important border for which people and goods are potentially barred from crossing without agreements in place.

Additionally, on UK ports that send goods back and forth across the English channel to the European continent, there is a high volume of goods that would slow to a crawl if customs paperwork had to be done for each item.

A risk that many pro-Brexit and anti-Brexit people fear is a “hard Brexit”, a situation where the UK leaves the EU with no plan in place for any of these details. In contrast, another risk that pro-Brexit people fear is that the UK government might decide not to leave the EU due to all of this complexity.

During this next week, UK’s Parliament will hold a series of votes deciding how to move forward. On April 10, leaders of the EU are going to meet for an emergency summit to discuss options on their side. If no deal is reached or the leave is not delayed, April 12 will be a formal Brexit.

Further complicating matters is that in late May, there are European Parliament elections. If Brexit is delayed into May, then UK citizens will be able to appoint dozens of members in the parliament of the institution they plan to leave. This presents a soft time limit on the EU and UK to finalize Brexit ahead of those elections without further delays.

Europe is also facing a slowing economy. The purchasing manager’s indices for Germany, France, and Italy have dipped below 50, indicating a contracting manufacturing environment. Germany and Italy had negative GDP growth in the most recent quarter. The European Central Bank has announced further monetary easing and mild stimulus.

Overall Eurozone GDP growth has decreased to an annualized rate of just 1.1%, which is the lowest rate since the European sovereign debt crisis from earlier in this decade:

Chart Source: Trading Economics

Additionally, the bond market is positioning defensively by buying long-term government bonds. In particular, German 10-year bond yields have dipped into negative territory due to strong demand and very low interest rates:

Chart Source: Marketwatch

A year ago, German bonds gave investors approximately a 0.76% interest yield. Today, the yield is down to almost -0.07%, meaning that bond holders actually pay the German government a small yield to hold German bonds. Considering that the inflation rate in Germany is 1.3%, investors in German bonds are losing purchasing power by holding those assets.

It’s a very unfavorable economic environment, and with interest rates already at rock-bottom levels, the European Central Bank likely has limited ammo to deal with an economic slowdown or recession.

If there’s a saving grace, it’s that stocks in the I Fund are cheap compared to U.S. stocks. Companies in the I Fund have an average price-to-earnings ratio of under 14.5 and a sizable 3.4% dividend yield. Meanwhile, companies in the C Fund have an average price-to-earnings ratio of 20.0 along with a smaller dividend yield of just 1.9%.

Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.