On January 19th 2015 I posted the TSP F Fund’s Last Hurrah. Today, we are going to look at how the last Hurrah worked out and how it foretells the final “Hurrah” in the stock market.
Of course, no one cares right now. The news is too good. Estimates of 50% earnings growth by late 2019 (up from 2017) are designed to make it hard to sell stocks. Tax cuts grow the economy, right. Heck, unemployment may go negative like interest rates in Europe.
And inflation will stay subdued even if it finally bumps a little higher than the central bank’s arbitrary 2% of consumer
punishment price inflation (CPI). And the housing market is so great today, most people could not afford to buy their house again. At the same time, the BLS inflation bean-counters tells us your new $800 iPhone costs only half as much as the $800 iPhone in 2006 adjusted for their quality adjustments. Life is good.
But for now we will put aside the euphoria and debrief the “TSP F Fund’s Last Hurrah” and see what we can learn.
My January 2015 premise was interest rates were bottoming thanks to the end of the long bond market bull that began before the TSP F fund’s inception. This meant the capital gains on lower interest rates that advantaged the fund were going to disappear. If rates remained flat but low, you were stuck with the low 2% ish yield going forward. And if interest rates climbed the capital losses were going to negate the yield while rates were climbing.
The TSP F fund tracks the same US aggregate bond index as the AGG ETF which is handy for producing the two charts below. The TSP chart includes dividends and the AGG ETF is price only. The first chart is price only and while the ups and downs look large, the price change only ranged between 105 and 113 or about 8%.
While I almost nailed the top, the European Central Bank (ECB) President did not like the idea of the free markets setting European interest rates. We all know economist with their academic models know better what interest rates should be (especially former Goldman Sachs directors). So the ECB drove European interest rates below zero. And the US Fed declared they were done raising rates after one tiny hike.
Why? Because they saw what we saw. The US stock market was looking over the abyss and Europe’s banks were in meltdown mode Greece as the catalyst. All of which was easily reversed with epic epic central bank money creation.
Now, I’ll admit I never expected they would be so reckless. You will have to wait to appreciate the full effects of the reckless part as they try to normalize this policy. The bottom line is US interest rates were dragged down with European rates and hit a second bottom in July of 2016 – the second last Hurrah.
When we add dividend yields to price movements we see that rising interest rates subtract from yield and result in flat total returns. While the ECB dragging interest rates lower provided a second last Hurrah, the bond funds were back in the Zero Total Return phase by mid-2016 and will stay there until US interest rates stop climbing.
The Last Hurrah was not the end of returns for the bond funds, but the end of the capital gains that everyone became used to. When we look at the past returns of the TSP F fund or bond mutual funds they included capital gains. If you look back far enough they also include an era of much higher yields then we have been in for the last few years.
One of the reasons I believe the Fed is raising interest rates at half any previous cycle is they do not want the capital losses to exceed the yield by enough to spook investors. The current pace pretty much offsets yield for several years. So expect the TSP F fund to be no higher in late 2019 than it was in mid-2016.
The Last, Last Hurrah
While the bull market in bonds was extended from early 2015 to mid-2016 thanks to negative interest rates in Europe, Europe will need to find away to undo their monetary mess. But more likely the markets will do it for them at some point. The whole globe’s monetary madness is about to get tested by the Fed raising US interest rates.
Inflation does not set interest rates. Supply and demand for bonds does. The Fed is not setting rates today so much as chasing them higher. And the present course is much higher by 2020.
A massive supply of bonds is going to be hitting the markets soon thanks to fiscal recklessness. My guess is our President will be blaming and threatening the Fed for too high interest rates by 2020. Reagan simply raised taxes 3 times after his big tax cut. Of course, he could admit when he was wrong and correct his mistakes.
The Republicans will insist on deep social spending cuts to bring down the deficit. And one will wonder if they did not notice what happened to Kansas and Greece’s economies and tax revenue when austerity was the solution. So prepare for the last, last hurrah before this comes to fruition because the stock market will figure this one out at some point like the wile e. coyote…
The Kansas Model
Most of the fiscal crisis’s we see today at the state and federal government level are due to lowering taxes in their past based on supply-side myths. Business Insider gave us a glimpse of what is to come at the federal level in their article.
… ask some Kansans and you’ll learn how that kind of tax cut could have serious unintended consequences.
“Kansas has been an unmitigated budgetary disaster,” Dr Lori McMillan, a tax-law professor at Washburn University, told Business Insider. “It was a very messy, blunt club when a scalpel was needed.”
The economic growth from the tax cuts never materialized. Kansas was saddled with an almost instantaneous budget hole, leaving schools and pensions drastically underfunded. Infrastructure repairs were put on hold. And to deal with a $700 million drop in revenue — almost twice what was predicted — Kansas raised its sales tax, hurting all residents, but especially lower income Kansans.
We are watching the markets for that Wile E. Coyote moment.
Invest safe, invest smart