What is going on with the stock market?
Are we coming to the end of a bull market or is the market pausing before pushing up again in the near future?
Company earnings are up substantially over the last five years but stock prices have not kept up with the rise in earnings. How come?
If you can definitively answer these questions, you are probably living on your own island somewhere in the world counting your multi-billions of dollars and not working as a civil service employee worrying about whether pay-for-performance will impact your average raise in 2007.
But for the rest of us, what is the explanation for the recent volatility in the stock market and the failure of stock prices to keep up with increased earnings?
With the big rise in stock prices earlier this week, the Standard and Poor’s 500 stock index is up 1.7% for 2006. (The TSP’s C fund is based on this index.) At that rate, you will obviously do better in the very safe and secure G fund which will probably give investors a return of about 4.5% for the year without any real risk of losing money.
For the month of July, your TSP stock funds have not done very well. As of yesterday, here are the results for the month of July for the TSP stock funds.
No doubt the shooting in the war in Lebanon is having an impact; higher oil prices, the continuing violence in Iraq, concerns about missles from North Korea and threats and belligerent statements from Iran all play some role in the value of stocks.
In part, the reaction of the American stock market to events around the world shows that we really are in a global economy. And, while we don’t like to think about it, the events of September 11 several years ago have changed America. We do not feel as secure as we did before. While the work of many federal employees and contractors has been crucial in sparing Americans from more catastrophes like we experienced with the attacks on the World Trade Center and the Pentagon, we know that additional terrorist attacks on our soil are certainly possible and are probably likely to occur.
Tobin Smith, a popular stock analyst frequently seen on Fox News and other financial news outlets, points out that the earnings per share for stocks in the S&P 500 were at $41 in 2001. In today’s market, the earnings per share for these stocks is up to about $90 per share. But, despite this increase, we have not seen a corresponding rise in stock prices. Your C fund provided a positive return for each of the past three years. But the S&P 500 stock index is now about where it was at the beginning of 2001.
In effect, America is now certainly part of the global economy and we are not immune from the lack of political stability in other parts of the world. Some public figures have recently said that we are now fighting WWIII. Whether you agree with that assessment or not, there is no doubt that our increasing awareness of Islamic extremism has contributed to uncertainty in the minds of investors. (The World War III analogy is not mine. Click here to see “What Makes a World War?” or check out “Newt is Right” for more on this statement.)
Financial markets do not react well to uncertainty. This uncertainty has had an impact on the pricing of American stocks. That doesn’t mean they will not continue to do well in the future; it does mean that events occurring on foreign soil are likely to continue to play a role in America’s economic future.
The stocks that have done well recently are energy stocks. That won’t be a shock to anyone who drives a car as we are paying, in some locations, about $3.00 for a gallon gas. That increase in price has not had any impact on demand and we are continuing to drive and have not yet found a way to decrease our dependence on foreign oil. The “sticker shock” of higher gas prices was apparently temporary as we have adapted to paying more to drive to work or the store. Of course, there is not a TSP fund that invests solely in energy stocks in any event.
To a large extent, foreign stocks have kept up and surpassed the performance of American stocks. International stocks have been doing very well for the past several years. The TSP’s S and C funds have gone down in value since January 3, 2006. The I fund is actually up more than 7% for the year and is substantially ahead of the C fund in overall returns since 2001. (Check out the annual TSP returns here in our TSP corner.)
Part of the reason for this change in recent years is that the higher price investors were willing to pay for American stocks has disappeared. America’s stable economic and political environment is no longer safer or more stable than some other parts of the world.
Our best hope may be that the war on terror that we are fighting, most notably in Iraq and Afghanistan, will eventually lead to a more stable economic and political environment. In the meantime, investors will remain uncertain and be less confident of future economic results. While stock prices will go up as company earnings increase, we may not see the higher multiples on stock prices we were used to seeing in domestic stocks as long as the instabiity and fear continues.
No one can tell you how to invest your retirement funds. Economic uncertainty, wars and political instability throughout the world will tempt some TSP investors to take all of their money out of stock funds and invest solely in the G fund. As noted at the end of a recent article (“When I’m 64“), that may be a less secure investment for current and future retirees who are likely to live longer and may outlive their financial resources if your investments do not keep up with inflation.
No doubt, all the uncertainty has prompted large numbers of TSP investors to put their money into the new lifecycle funds. If you are a pessimist or just an investor who thinks the world is too uncertain for you to decide how to invest for your retirement future, that may be a good option. (See Lifecycle Funds: Making a Model Retirement Program Even Better)
Enjoy the financial ride and invest carefully for your financial future!