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When the federal workforce and furloughs combine, investors should be ready to make potentially the biggest bond play of the decade.

If sequestration talks between congress and the President do not satisfy either party enough, the majority of the 2.1 million civilians working for the fed will face up to 24 days of unpaid furlough a year. While this is bad news for G-men, Moore's article last week cites Wall Street's optimism; speaking to how sequestration might actually help government spending and GDP sync with more sustainable levels. In perhaps the long run this 'lack of a plan' could be the best solution. However I would argue furloughing employees, combined with the program and service cuts outlined in sequestration, will generate a much more immediate domino cascade of cuts and defaults down through the state and local government pyramids, eventually bleeding into industry.

And what about those employees? With the average age of the federal work force approaching 50, and over a third already eligible to retire, many of the baby-boomer generation will likely see sequestration as that final push. In fact, half of that third have been eligible for over 3 years, gradually building back up their assets from the 2008 crash, just waiting for the right time to retire.

While the old investment idiom of 100 minus your age for determining equity allocation is just that - old; it's a hard sell to convince a freshly retired, newly jaded government worker to trust in the market. Instead, I foresee furloughs accelerating senior government employees' migration out of equities and into bonds.

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Federal Demographics And Their Implications

Predicting the what, where, and how effects of sequestration is difficult, since these measures have not yet been fully flushed out by the individual agencies. The current plan calls for $1.2 trillion in across the board spending cuts over the next 10 years; while the intent is to peanut butter spread these cuts across the entire government, inherent variations in key agency demographics will inevitably generate an income loss disparity. Those key demographics are age, and occupation. Understanding these will help us determine what we need to watch for come furlough season. For an in-depth look at my methods see my instablog post.

Age

The Federal Government generally follows the expected trend where older employees earn higher salaries. Since at present, sequestration will not discriminate on the basis of seniority, furloughs will be felt at all ages. When the retiring baby-boomer generation prepares to leave the Government en mass, they will take with them the largest amount of income. Yet this group also will take the largest amount in lost income, as shown on the chart below. I'm no financial psychologist, but I'll wager someone who just lost 8% of their annual income in the year they planned to retire will probably want to move their assets into lower risk, lower volatility investments (i.e. bonds).

From this data we can see furloughs will cost retirement eligible employees over $3.4 billion in this year. Not an insignificant amount to vanish from the market.

Occupation

Occupation data might be a bit more obscure; what the chart below shows us is both the distribution of occupations across the federal-sphere as well as the relative salaries of those occupations. The numbered pre-fixes are OPM standard career codes, I've left them on for those familiar with the scheme.

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Notice the 20 hardest hit professions are all white-collar. While it's good to see the backbone of America will be the least impacted, the investment market should hold a different view. As Gallup reports the majority of investors are mid-to-upper class, degreed, white collar employees...which happens to be the majority of the federal workforce. As with senior employees, a sudden drop in this demographic's personal investment income will 1-for-1 result in much less money entering the market.

The Thrift Savings Plan

Okay, so demographically we're able to see the soon to retire workforce is in a position to lose a lot of income. However the real money movements will be when this demographic reevaluates their retirement assets.

Federal Employees participate in one of the largest private 401(k) plans in the nation, the $330 billion Thrift Savings Plan or TSP. There are two unique caveats about the TSP investors should be aware of, such as their agreement with the U.S. Treasury to issue special non-marketable government securities known collectively as "The G Fund". The other is all of the assets of the TSP are held in trust, though not owned, by BlackRock (NYSE:BLK) and are regulated by the Comptroller of the Currency. As such, none of the TSP's 5 core funds are publicly tickered, though they are responsible for moving billions to and from equities. During debt ceiling debates last December federal employees took $3 billion out of equities.

Aside from the G fund, the only bond investment federal employees can make is the "F" Fund, which tracks the Barclays Capital U.S. Aggregate Bond Index. When the accelerated influx of new retirees reallocate their assets, this is where they have to go. The chart below shows the general concept:

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The Bond Play

Investors looking to capitalize on this influx need look no further than tickered funds that also track the U.S. Aggregate Index:

Vanguard Total Bond Market ETF (NYSEARCA:BND)

iShares Core Total U.S. Bond Market ETF (NYSEARCA:AGG)

SPDR Lehman Aggregate Bond ETF (NYSEARCA:LAG)

Schwab U.S. Aggregate Bond ETF (NYSEARCA:SCHZ)

As the chart below shows, equities have vastly outperformed bonds in the last 12 months, though things look due for a change:

(click to enlarge)

Investors should note there is always the risk that sequestration debates will eliminate the need for furloughs, in which case federal employees may continue to retire at normal rates.

Conclusion

As harped on by many (the President included), sequestration was not supposed to generate blind, across the board cuts. If federal employees are furloughed as laid out in agency plans and public statements, the long term and complex repercussions will be felt throughout the nation. Though furloughs call for an even spread, variations in the federal employment demographic will generate an inevitable lost income disparity that will hit the 30% of retirement eligible employees the hardest. Expect to see large institutional movements out of equities and into bonds as the accelerating federal retiree wave re-allocates their assets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Bond Play: A Look At Federal Furloughs