TSP

Late in the market cycle with high stock valuations and an inverting yield curve: It's a good time to assess your current risk tolerance and risk exposure, and invest accordingly - just don't overreact.

Lyn Alden

This past week marked the fifth straight down week for the Dow Jones Industrial Average, which is an index of 30 top blue chip companies that are also in the S&P 500 and C Fund. It is the first time since 2011 that the Dow has been down for 5 consecutive weeks.

Additionally, the S&P 500 has seemingly “triple-topped” over the past year and a half, which is generally a negative sign, especially as far as we are into the market cycle with high stock valuations and an inverting yield curve. In other words, the market hit a peak in early 2018, and since then it roughly reached the same level two more times before falling again:

Chart Source: Google Finance

The ongoing trade dispute between the United States and China appears to be driving some of this negative sentiment. Trade talks broke down in recent weeks, which resulted in increased tariffs and heightened restrictions on technology business partnerships.

The market could certainly turn around and reach new all-time highs again before the end of the cycle, but at the current time, market risk is increasing.

Consumer Confidence: Present Conditions vs Future Expectations

Over the past few months, some bearish hedge funds including Hussman Funds and Crescat Capital have pointed out that consumer confidence surveys are indicating a contrarian indicator for a potential market cycle top.

Specifically, the spread between consumers’ assessment of their present conditions and consumers’ expectations of future conditions has hit what may be a peak. Historically, whenever the spread between consumer present conditions vs consumer future expectations hit a level this wide, a recession and bear market followed over the year.

Past performance doesn’t guarantee future results, but it’s worth being aware of:

Chart Source: Crescat Capital

But this doesn’t mean that investors should freak out or make big asset allocation changes. Instead, it just pays to re-assess risk and make sure your personal finances are in order.

Many people take too active of a role with their portfolio, trying to time every market movement. For most of them, this is historically a recipe for underperformance. Rather than doing that, start with the following two steps.

How much risk can I tolerate? 

First, assess your current risk tolerance and risk exposure, and invest accordingly. If you are nearing retirement, you probably don’t want to be 100% in equities at this time, for example.

If you have significant assets, hiring a fee-only fiduciary financial advisor to go over your current situation with you might be the prudent thing to do. These types of advisors don’t have conflicts of interest to sell you expensive funds or annuities, and instead are just paid to give objective advice. Whenever you work with a financial advisor, make sure you ask and understand what their sources of compensation are when it comes to helping you manage your money.

LifeCycle Funds

Alternatively, investing in the lifecycle fund that most closely matches your expected retirement date is generally considered a good approach for risk-adjusted returns that are appropriate for your age.

Last year when we saw market turbulence, I wrote about 2 ways to preserve TSP capital. This is a good time to review that article and determine ahead of time what your plan will be as markets do whatever they will do over the next few years. The last thing that you should do is to not have a plan, and then sell at a market bottom in a panic.

Second, once your risk management plan is in place, bolster your personal finances rather than worry too much about your investment portfolio. Consumers are describing their current situations as great but future expectations as weaker. Considering that the official unemployment rate is at multi-decade lows and we’re in the longest economic expansion in U.S. history, the odds suggest this may indeed be the case. Things could potentially get better but by many metrics we are already at a peak, and have been in a pretty good place economically for the past few years.

Remember that it was just a few months ago that many federal workers were furloughed during a partial government shutdown, and hundreds of thousands of them were living paycheck to paycheck and started to run out of cash.

This is a good time, when cash is flowing and markets are high, to make sure you have a significant cash buffer. Can you ride out a multi-month period without a paycheck if you need to? Is the income/expenses spread within your family financially strong enough to withstand a job loss of your spouse for a period of time, if she or he works? Have you eliminated or avoided credit card and other high interest debt so that your household balance sheet is strong?

Just like squirrels store acorns for the winter during the warmer months, strong economic and market periods like this are a good time to store money for the leaner times.

See also, Two Smart Ways to Preserve TSP Capital

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.