By: Lyn Alden
All five TSP funds are up so far in July, and market volatility remains at historically low levels.
The G Fund has risen about a tenth of a percent since the start of the month, while the F fund is up more than half a percent.
The C Fund, which follows the S&P 500, and the international I Fund are both up over 2%, while the small-cap S Fund has had decent performance with 1.6% gains.
What’s a smart TSP investor to do? Read on.
Federal Reserve outlook
Perhaps the most interesting market news of the month so far was Fed Chair Janet Yellen’s semiannual monetary report to Congress. She spoke at length about the state of the economy, but the things that all investors were focused on were her thoughts on interest rates and the balance sheet of the Federal Reserve.
On the outlook of interest rates over the next several years, she had this to say:
“Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.
But because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal.
Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.”
-Janet Yellen, Federal Reserve Chair Report to Congress, July 12
Low Interest Rates
The Federal Reserve’s dual mandate is to maximize employment and maintain stable prices (inflation).
To increase employment, it typically lowers the Federal Funds Rate during recessions, which lowers interest rates for virtually all debt and interest-bearing investments in the economy. This is meant to spur economic growth by allowing businesses to borrow cheap money to use for expansion.
To avoid too much inflation, however, the Fed generally raise the Federal Funds Rate during expansions, and therefore all interest rates, which is meant to help keep the monetary supply in check and avoid high inflation. The Fed targets 2% annual inflation as the ideal figure.
We’ve been in a very long period of low inflation, which has allowed the Fed to keep interest rates low during this expansion. This is beneficial to stocks in the C Fund and S Fund (and I Fund, because foreign central banks are doing the same thing), but negatively impacts bond returns in the F Fund and G Fund.
Yellen’s comments show that we may very well be in for a long-term period of low interest rates, only rising very gradually.
Unwinding the Fed’s Balance Sheet
In addition, Yellen spoke of how the Federal Reserve plans to gradually reduce its balance sheet. During and shortly after the major recession of 2008/2009, the Federal Reserve dramatically increased its balance sheet from less than $900 billion in assets to over $4.5 trillion in assets through quantitative easing. Now, they seek to slowly unwind their positions by being a net seller of securities.
If they do this too quickly, it could disrupt the economy, but they plan a very gradual approach. Only time will tell to see if it goes smoothly.
The Current State of the Market Expansion
Something I’ve been keeping my eye on for a while is the current length of the market expansion we’re now in.
It has been eight years and counting since we left the Great Recession, which makes this the third-longest market expansion in U.S. history.
Earlier this month, J.P. Morgan published their quarterly guide to the markets, and here’s the chart that fully captures the current expansion as it compares to prior ones:
The chart shows that the current expansion (light blue line) has been the third longest, but among the weakest of expansions in the post-WWII era.
The bullish interpretation is that the weakness of the expansion, combined with the Fed’s policy of low-for-long interest rates, could allow this market expansion to extend into record-length territory. It might not be the biggest expansion ever, but it could certainly be the longest.
The bearish interpretation is that if we enter a recession with such weak growth and interest rates already so low, the Fed won’t have many tools available to help spur growth again, and we’ll find ourselves in a long-term malaise.
A smart TSP investor’s safest bet is to remain diversified across all the TSP funds, and push his or her savings rate as high as possible to keep the portfolio growing.