TSP

Washington, DC Nov 14 2019: Federal Reserve chair Jerome Powell appears before the House Budget Committee on Capitol Hill. The hearing was held to hear Powell's testimony on the outlook of the economy, which has seen record highs of the S&P 500 stock market.

Lyn Alden

Last week was a relatively flat and slightly down week for the S&P 500, which the C Fund tracks. The market continues to hover near all-time highs.

Chart Source: CNBC

The CBOE VIX index that measures market expected volatility (often called the “fear gauge” of the market) is currently near historic lows. In other words, market participants are expecting very little volatility for the market and are willing to make bets specifically that the market will not be volatile.

This past week, the VIX hovered between 12 and 13, which is typically the lower bound for volatility. It rarely goes much below that. There were brief periods in late 2006 and late 2017 where volatility went to extreme lows near 10, but those periods are rare, and usually 12 is about as low as it gets.

Historically, there is a strong but imperfect inverse correlation between expected volatility and market performance. In other words, local tops in the stock market (good contrarian selling opportunities) tend to have low expected volatility, while local bottoms in the stock market (good contrarian buying opportunities) tend to have high expected volatility.

The next chart shows historical volatility (blue line) compared to the total U.S. stock market as measured by the Wilshire index, which is similar to the C Fund and S Fund combined with about an 80% weighting towards the C Fund (red line):

Chart Source: St. Louis Fed

This is a good time to check your asset allocation and your emotional decision making. We’ve had a stock market run-up throughout November, and volatility is near record lows. Are you chasing the market higher, or are you sticking with your asset allocation plan?

A Glimpse at the Economy

Aside from the stock market, the U.S. economy has been slowing in 2019, meaning that it has had positive growth but at a much lower year-over-year growth rate than it had back in 2017 or 2018.

The purchasing manager’s index, which is a useful real-time indicator for economic strength, has shown some stabilization in October and November, meaning it stopped falling and even began rising slightly. For this indicator, anything below 50 is contractionary while anything above 50 is an expansion:

Chart Source: Trading Economics

During 2012/2013 and 2015/2016, the U.S. economy experienced major slowdowns that touched below 50 for the manufacturing PMI, but bounced back. So far, this happened again in late 2019, where the manufacturing sector is flirting with a contraction but not persisting within it.

This is a useful indicator to watch to see if we get another full cycle of growth during this expansion, or if this double-dips back into a contraction territory.

The bullish argument for the economy is that the corrective rate cut and bond-buying program by the Federal Reserve is helping to stimulate another cycle of growth, and that international central banks are doing similar stimulus programs.

The bearish argument is that this small uptick is just due to demand being pulled forward before additional tariffs kick in on December 15th. In other words, U.S. businesses are buying more Chinese goods before extra tariffs go into effect, and Chinese firms are buying more critical semiconductors from U.S. firms to stockpile them in case they get blacklisted from buying them in the future.

We’ll get more clarity as we go into December and January, but at the moment we remain at an important economic inflection point.

A note on asset allocation

Investors should be careful not to chase recent performance based on quick emotional decisions. Asset allocation should usually be based on your long-term goals and your risk tolerance. Decisions to increase or decrease your allocation to equities, for example, should be well thought-out and applied for good reasons. For many investors, the Lifecycle funds can be ideal investment vehicles because they are consistently diversified and rebalance themselves over time.

More on the Lifecycle funds here: The Pros and Cons of Lifecycle Funds

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.