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Longer term outlook TSP returns
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Longer Term Market Outlook
Updated 1/01/06
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Mid
Term Outlook (6 months - 1 year)
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We begin 2006 with
some trepidation about the short term, but also with some excitement for
the potential strength in stocks by year’s end.
We anticipate the start of 2006 to bring with it some bumps and bruises
and we plan to start the year in a similar posture to our late 2005
posture, which is defensive. Unfortunately for us at TSP Talk, we had
anticipated this weakness to come prior to the new year and it cost us
from participating in the late 2005 rally.
Small caps and international stocks did well again but it wasn’t really an
outstanding year for stocks in general - The S&P 500 was up 3.00% (The C fund was up
4.96 %) in 2005. The Dow was actually down 0.61%. And the
Nasdaq was up just 1.37%. We spent
much of 2005 in defensive mode because our indicators were telling us
that it may not be a great year. Even though no real harm was done to
stocks, those returns tell us we were right to be on the cautious side.
We ended the year rather flat, being up just 0.51% in our active account
but our longer term outlook suggested allocation managed a 8.50% gain.
A bad move in late October cost us some gains in our trading account but we still feel we
approached 2005 correctly.
Ironically we would have done better had we either been more
conservative and stayed in the G fund more often, or were more
aggressive and better utilized the S and I funds. It seemed as if
every time we stuck our necks out, like during the historically strong
December holiday week, we were punished.
The key to timing the market (not day trading) is to play defense when
things are not looking right, and to get very aggressive when they are.
In our prior semi-annual longer term comments (July 2005) our final
words of wisdom were:
If there are going to be any major
fireworks for the market this year, I expect it to be later rather than
sooner. Until then, use weakness to add to the stock funds. Use strong
rallies to lighten up. That should keep your account in good shape for
the coming rally which I suspect will start late this year or early next
year.
That was some good
advice, and I wish I listened to it myself. While we did get a
nice rally in late 2005, the actually
rally I talked about did not happen and looks as if it is not going to begin until
sometime in 2006 as we await
the next indicator cleansing phase.
We do believe 2006 is setting up nicely for a big year. That is after
we experience a pullback that will bring the intermediate term
indicators closer to a buy signal. By year’s end we foresee a strong
double digit gain for the S&P 500 in 2006 – as much as 25% to 35%. So,
we are not only hoping to be a part of those big gains, but if we play
it right and wait it out, we could miss any early pullback which would
magnify our gains. And after the mediocre performances of 2004 and
2005, we are really excited about it.
Why will it be a good year? Three reasons: Psychology, monetary
conditions, and valuation. The first two have been in some trouble of
late and have kept us in defensive mode.
The longer term sentiment and overbought/oversold indicators, which make
up much of the psychology leg, have been telling us we need a decent
pullback to give investors time to refuel. If too many people are
bullish and already heavily invested in stocks, there isn’t much fuel
left in the tank to keep things moving higher. That can keep a cap on
stock prices. You want to see investors getting nervous, holding on to
cash, and even doing a little panic selling as the indexes move down.
Pessimism turned to panic is what puts in major market bottoms. We saw
a little of that in late October 2005 - Just not enough to affect the
longer term indicators.
The other leg of the market that has had trouble is the monetary
conditions. Rising interest rates and an inverted yield curve top that
list. The good news is that the new Fed Chairman, Ben Bernanke, is
likely to pause on the rate hikes. We are also anticipating the
Fed to stop chocking the economy and to start adding to the money supply
as signs of a weakening economy present itself in the early 2006
reports. That tends to bring investors back
to the market.
Valuation is the one leg of the market that has remained strong and has
been the main reason why the pullbacks over the past two years have
remained on the mild side. The best way I find to decipher
valuation is to compare the yields of the S&P 500 earnings and the 10
year Treasury Note. The S&P 500 earnings yield is currently
6.64%. When compared to the yield of the 10-year Treasury Note (as
of 12/30/05, 4.39%) that makes
stocks undervalued by 33.8%. In the next few years we will see
these two yields move closer together. That will happen by stock
prices rising, bond yields rising, S&P 500 earnings dropping, or a
combination of the three. So with the 10-year Treasury bond yielding
just over 4% and the S&P 500
trading at just 15 times estimated earnings, the market is at its
deepest discount relative to bonds in two decades.
I don’t want to go into too much of a short term discussion in these
longer term outlook comments, but we plan to start the year in this less
active account with a little bit higher cash than we had all of last
year (we had 15% in the G fund throughout 2005.) Then, sometime during the
first three months of 2006 when the indicators repair themselves, we
will move closer to a 100% stock fund allocation.
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| Long
Term Outlook (3 plus years) |
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Not much to say here except that I am bullish for the long term. Of course there will be swings over the course
of three plus years but if you are not the type to watch the market on a
regular basis and you do have three or more years before you need your TSP
funds, stocks are the place to be. You can use the table below
as a guideline, just consider your risk tolerance and also when you
will need your money when choosing an allocation.
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| Allocation |
If
I were a long term investor not looking to make many allocation changes, I
would add some cash and bonds a few weeks waiting for the first major
pullback in 2006 before getting back to a fully aggressive position. You can find your risk tolerance level and
choose an allocation you are comfortable with based on it. As I
mention, after any major pullback in 2006, we will look to go 100%
stocks in our aggressive, less active account. Here are some
possibilities:
| Risk Tolerance |
G Fund |
F Fund |
C Fund |
S Fund |
I Fund |
| Aggressive |
10% |
15% |
25% |
25% |
25% |
| Moderate |
20% |
15% |
25% |
20% |
20% |
| Conservative |
40% |
15% |
25% |
10% |
10% |
Remember,
this is a less
active, hypothetical account and it has done well over the years.
But it is not what we do with our own personal TSP accounts. We
tend to be more active.
These would be basic
guidelines for the longer term, buy and hold type of investors who make few transfers during the year.
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