The hot US stock market couldn't handle the renewed slide in bonds, leading to a decline of over 4% for a balanced portfolio of stocks and bonds for the month. Despite this, the economy remains strong, even as 30-year fixed rate mortgages approach 8%, reminiscent of the worst of the bond market hit in 2022. Banks are showing signs of strain again, as they grapple with a portfolio of long-term, low-rate loans while needing to offer rising yields to depositors.

For September 2023, our Conservative portfolio declined by 4.71%, and our Aggressive portfolio fell 3.71%. Benchmark Vanguard funds for the month were as follows: Vanguard 500 Index Fund (VFINX), down 4.77%; Vanguard Total Bond Index (VBMFX), down 2.49%; Vanguard Developed Mkts Index (VTMGX), down 3.71%; Vanguard Emerging Mkts Index (VEIEX), down 2.06%; and Vanguard Star Fund (VGSTX), a global balanced portfolio, down 4.04%.

Despite its recent drop, the S&P 500 remains up around 13% for 2023. In contrast, longer-term government bonds have experienced significant declines. A 50/50 portfolio consisting of the S&P 500 ETF (SPY) and the long-term government bond ETF (TLT) is approximately flat for the year, dividends included. Our higher-risk portfolio has registered a 1.35% return, while our lower-risk portfolio has decreased by 1.13% year to date.

The primary areas that have been performing well in the market (though some are cooling down) include technology, which is still up around 20% YTD, and growth sectors in the US. While some foreign markets like Japan are performing strongly this year, most are lagging behind the US. The strength that value stocks displayed in 2022 has waned in 2023, with these funds now in the red. Small cap stocks are barely holding ground with a 3% return for the year.

The weakest performers include assets that investors previously favored when rates were near zero and below inflation — such as gold, high dividend stocks, and utilities. These so-called 'safe' inflation hedges or assets offering inflation-beating yields are now under pressure. Utilities have fallen by 12% this year, real estate funds by over 5%, and precious metal funds have declined around 10%. Investors don't need to look far for safe yields now, as T-bills are offering around 5.5%.

Why haven't higher rates stifled the economy or the stock market as anticipated? Perhaps many had envisaged a near future that mirrored the last 15+ years, with persistent low rates to support the economy where the risk averse are punished for being too conservative. This optimistic projection is rapidly changing as the possibility of enduring higher rates becomes more evident. For those purchasing homes at current peak prices with almost 8% mortgage rates, refinance opportunities at lower rates in the coming years might become scarce.

The US economy's resilience may be partially attributed to how many Americans having locked in low rates with 30-year fixed mortgages of around 3%. Rising inflation is simultaneously pushing up home prices and salaries, and with the surge in cash yields, those brave enough to move away from their zero-interest bank accounts are seeing over 5% yields. However, challenges could be on the horizon for commercial borrowers with short-term or adjustable-rate loans.

If the aim is to curtail consumer spending to combat inflation, then tax hikes and government spending cuts might be necessary – neither of which we're currently seeing. Relying solely on rising rates to cool down the economy could lead to a financial crisis, even when consumers are still splurging on luxuries like $1000 Taylor Swift tickets.

Another factor to consider is that, at some point, government bonds might outperform stocks over a lengthy period, perhaps decades. If an investor had purchased a 20-year government bond in 2000 and, upon maturity in 2020, reinvested in T-bills, the returns would have been on par with the S&P 500, dividends included. The catch is that one would have enjoyed the consistent 6%+ yields from bonds and avoided the recent bond market crash since the bond matured in 2020.

In the current scenario, we're nearing the 6% yield for 30-year bonds seen in early 2000, with rates currently hovering around 5%. While stock yields aren't as low as they were then (meaning stocks are not quite as overpriced), they are not far off, sitting around 1.5%.

The tech innovations from 2000-2020, including the spread of the internet and smartphones, resulted in an average annual return of about 6.5% in the S&P 500 stock fund. But we also saw government debt soar from 60% of GDP to 120%. Without a similar debt-driven boost in the near future and with an aging population, economic growth could be stifled, barring any significant shifts, such as a robot-driven economy.

Ultimately, the primary hesitation against heavily investing in 5% risk-free long-term debt arises from the potential for rates to climb even further, which could further depress longer-term bond prices. Although we haven't observed panic selling of bond funds—a sign that might indicate a good entry point—such a scenario might never transpire. This is especially true if there's significant demand for 6% government bond yields. After all, achieving returns better than 6% long-term government bonds is difficult, even under nearly ideal economic conditions.

One of the ETF holdings in our Conservative portfolio, the NightShares 2000 ETF (NIVM), was liquidated last week. For now, we're shifting the 5% allocation to cash via an ETF specializing in 6-month T-bills. This means we're transitioning from a no-yield cash position to an actual cash-like fund with a much higher yield (5.19% 30-day SEC Yield / 5.39% Yield to Maturity) and low fees. We believe this is a move everyone at a brokerage firm should consider for their cash holdings. Vanguard stands out as the only major brokerage platform offering a solid money market fund sweep option, with Fidelity following closely. For others, trading into a cash-like fund is necessary, especially since the cash sweep accounts remain at sub 1% yield, which was acceptable when rates were near 0%. A sweep account is where cash is held between trades.

With risk-free yields now soaring above 5%, courtesy of the Federal Reserve's ongoing anti-inflationary measures, short-term treasuries or T-bills provide an almost risk-free opportunity. This yield is notably higher than the 100-year historical T-bill average return of around 3.5% and an inflation rate of approximately 3%. Moreover, these returns are significantly above the trailing 20-year averages, which are around 1.3% for T-Bills and 2.5% for inflation.

Our choice is the relatively new BondBloxx Bloomberg Six Month Target Duration US Treasury ETF (XHLF), which focuses on 6-month treasury bills. This fund has a minimal 0.03% fee and yields over 5%. It might slightly lag behind other shorter-term T-bill funds if rates keep rising. We believe such rate hikes will soon stop then settle into a historically high plateau until something breaks in the markets, real estate, or economy.

Another option is the iShares® 0-3 Month Treasury Bond ETF (SGOV), although its annual fee could rise from the current 0.07% to 0.13% next year once the fee reimbursement expires. Unlike SGOV, BondBloxx doesn't employ temporary introductory fees. Generally, these funds should outperform most house money market funds on brokerage platforms. The WisdomTree Floating Rate Treasury Fund (USFR) and the iShares Treasury Floating Rate Bond ETF (TFLO) are also worth noting. Though they have a higher fee of 0.15%, the returns on floating rate notes (FRN) might justify the cost, especially since FRNs typically offer a slight premium over short-term T-Bill rates. Also note the above funds are state tax free as the income is essentially 100% from the treasury.

In our client accounts, we do incorporate some direct T-Bill and FRN purchases. However, for the majority of situations, these above funds prove invaluable. Any minor fee concerns associated with these funds pale in comparison to the significant lost opportunities presented by bank or brokerage cash accounts in today's climate. It's crucial not to settle for sub 1% returns in a world yielding 5%, even if your bank or broker might prefer you to do so in order to offset their own loan losses from rising rates.

While these funds resemble almost risk-free cash-like instruments, short-term treasury funds such as the Schwab Short-Term US Treasury ETF (SCHO) can experience slight fluctuations with rapid rate rises. However, they might outperform lower maturity cash funds if rates start declining rapidly.

We're also rebalancing some holdings, as stocks have recently outperformed while bonds have lagged, with long-term rates revisiting their 2022 highs. For instance, if a stock fund's allocation increases from 10% to 12% and a bond fund decreases from 10% to 8%, we're making adjustments. In the case of our Vanguard Extended Duration Treasury ETF (EDV), we're making substantial purchases, implying our rebalanced portfolio will bear more interest rate risk in the near future. If rates rise further, we might pivot more towards bonds, especially if stocks continue their current upward trend.

Specifics about the liquidated fund:

The NightShares 2000 ETF (NIVM), which was recently liquidated by its sponsor, was based on the historical observation that stocks typically secure most of their gains overnight. The strategy was to buy stock index futures at market close and sell them the next morning, remaining in cash during the day. Unfortunately, this approach was less than successful.

We had initially reviewed this pattern over a 20-year span with our own research and found it promising, especially during bear markets. The potential downside was also less pronounced than with traditional stock indices.

However, the fund disappointed on multiple fronts. Our Conservative portfolio saw an investment of $5,908.82 on 06/30/22 or $29.99 a share, yielding a return of only $5,512.15 upon its liquidation on 8/15/23. This near 7% negative return was a letdown. Small-cap stocks like the Russell 2000 did underperform the S&P500 by about 7%, but this doesn't explain the fund's subpar performance as both small and large cap were up during this time frame.

NIVM's downfall can likely be attributed to two main challenges. Over much of the last year, the trend has shifted: buying the market in the morning and selling in the evening has produced similar results to holding onto the Russell 2000, but with less volatility. This night trading strategy failed to offer the expected rewards, though this has happened historically as well. Moreover, the fund seemed unable to effectively replicate even this modest night return, indicating implementation issues. Spotting a historical pattern is one thing, but real-world application, with all its inherent costs, is another.

In hindsight, shorting this fund while going long on the Russell 2000 would've yielded better results. However, in recent weeks, the pattern of nights outperforming days seems to be making a comeback, although it's uncertain if the fund would have capitalized on this trend if it remained active.

The stock market is now up over 20% from the lows last year, officially entering a bull market, though still down around 7% from the highs of early 2022. The market is being driven by mega-cap growth stocks, fueled by optimism surrounding a new tech bubble of artificial intelligence and a Federal Reserve pause in rapid rate increases. Inflation is subsiding but remains well above the 2% target. Bonds have barely moved upwards for the year.

Our Conservative portfolio gained 2.41%, and our Aggressive portfolio rose by 3.47%. Benchmark Vanguard funds for June 2023 were as follows: Vanguard 500 Index Fund (VFINX) was up 6.60%; Vanguard Total Bond Index (VBMFX) was down 0.38%; Vanguard Developed Mkts Index (VTMGX) was up 4.44%; Vanguard Emerging Mkts Index (VEIEX) was up 4.30%, and Vanguard Star Fund (VGSTX), a total global balanced portfolio, was up 3.80%.

Considering our heavy exposure to value stocks and bonds, we're surprised to be at least in the ballpark of the Vanguard benchmark total global portfolio fund. This is despite the tech and large-cap growth market quickly outpacing us.

Much of the optimism is centered on a new tech stock boom, driven by existing AI developments. It remains unclear how the rest of the economy will fare if AI dreams come true. Individual stock speculation is making a comeback, along with crypto speculation — the bubble that just won't burst. Fund investors have mostly been exiting stocks since last summer — a move which seemed to indicate that stocks were in a good place. However, we didn't take advantage because rates were high enough to be a good alternative to stocks. In June, fund investors started returning to stocks in the most significant numbers since the market peak in early 2022.

If the 2022 bear market was 'fixed' with 1% fed rates, we probably would have jumped into stocks as well. But the allure of a 5%+ risk-free rate was too compelling. This may prove too risk-averse, especially if inflation drops and the Fed lowers rates.

Stocks in the early 2000 internet bubble were at roughly the current high valuations and cash yields were about the same in the 5-6% range. From that point, stocks only returned just under 7% a year with dividends.

Will the AI boom make up for current high prices? Unlikely, as the 2000 bubble was essentially pre-internet and smartphone boom. Plus, we now have more government debt relative to GDP, limiting opportunities to boost the economy. We're sticking with cash and bonds for now.

Our only really successful recent buy was Vanguard Communication ETF (VOX) last year. Although it continued to fall until November, it's now up around 13% on fast-rising big-cap tech stocks that comprise part of the fund. The fund was up 4.75% for the month and 29.67% for the year. The S&P 500 outperformed around 90% of the 100+ fund categories once again, and beat all of our funds except Franklin FTSE Brazil (FLBR), which was up 15.01% for the month. Inflation-oriented and commodities investments are still lagging this year, but this region is doing well. Conversely, Franklin FTSE China (FLCH) is down almost 5% for the year, even after a positive 3.95% month.

There's no way to predict how far this new tech bubble will go. In theory, it's at the early stages, and there's much more money that could flow back into stocks. It seems the Fed would consider speculative mania too close to an inflation fight and, even if they don't raise rates, the Fed probably won't lower rates with rocketing crypto and tech. The future largely depends on the real estate sector, which has held up despite near 7% mortgages. The mini bank panic is now in the rear-view mirror, but questionable loans haven't really gone bad yet.

This effectively summarizes our current strategy: we're sticking with our holdings in what might be seen as unexciting value and bonds. We're considering a few minor adjustments, such as potentially reducing our stock holdings and increasing our cash reserves. The rising trend in tech and AI development is intriguing, but it could just be the precursor to a new bubble that might burst quickly, similar to the pre-2000 internet bubble — only now we're already in a valuation zone akin to late 1999. Even with rate increases stopping for good at around 5% and AI turning out to be far more than just cool chats, future returns likely won't beat those from 2000 to now.

This year has been marked by turbulence in the banking sector. The total assets of failed banks already exceed the inflation-adjusted assets of the banks that failed in 2008 during the financial crisis. The first failure occurred less than 60 days ago. Although there were 25 bank failures in 2008, the current situation involves larger regional banks dealing with significant depositors. So far, the list consists of just three banks: Silicon Valley Bank, Signature Bank, and more recently, First Republic. These stark figures suggest we are likely to surpass the total assets of all the banks that collapsed during the 2008 crisis, which saw elevated failures through 2012 due to massive losses from aggressive real estate lending during a substantial housing bubble.

Our Conservative portfolio gained 1.39%, and our Aggressive portfolio gained 1.16% in April. As for the benchmark Vanguard funds for April 2023: Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) was up 1.56%, Vanguard Total Bond Index Vanguard Total Bond Index (VBMFX) was up 0.54%, Vanguard Developed Markets Index Vanguard Developed Mkts Index (VTMGX) was up 2.55%, Vanguard Emerging Markets Index Vanguard Emerging Mkts Index (VEIEX) was down 0.66%, and Vanguard Star Fund Vanguard Star Fund (VGSTX), a total global balanced portfolio, was up 0.58%.

The best performers in our portfolio were Vanguard FTSE Europe (VGK) up 4.13%, Franklin FTSE Germany (FLGR) up 3.69%, and Franklin FTSE Brazil (FLBR) up 3.42%. On the downside, Proshares Short Bitcoin (BITI) was down 3.18%, UltraShort Bloom. Crude Oil (SCO) was down 3.97%, and Franklin FTSE China (FLCH) fell 4.27%.

In the midst of this banking sector upheaval, the broader stock market (surprisingly) remains somewhat resilient. While tech and startup stocks are still down significantly even with the big rebound this year, the S&P 500 ended April only about 10% down from its peak at the end of 2021. This lag in the broader market's response to a banking crisis is not entirely unexpected, as investors often anticipate the containment of the crisis or even a potential boost to the economy and stocks via lower rates.

Bank stocks, on the other hand, tell a different story, down about 50% from their peak in early 2022. Warren Buffett, swimming in cash, has steered clear of buying hard-hit banks, signaling potential long-term concerns. These banks are burdened by massive unrealized losses from loans written just a few years ago when generous stimulus spending and loose monetary policy led to trillions in new bank deposits. As depositors now seek higher yields, banks may find themselves in a precarious position, having to offer 3-5% rates without earning much due to their preexisting condition of low-yield loans in their portfolio.

All the failed banks thus far have a few things in common – a significant presence in tech-heavy California, a focus on large super-prime customers with deposits well above FDIC limits, and some exposure to crypto deposits. It's worth noting that the involvement with crypto has played a role in triggering the bank run, further exacerbating the crisis. Despite the increasing mainstream acceptance of crypto, it remains a destabilizing force for traditional banking institutions.

Interestingly, mega banks, which have been under stricter regulations since the 2008 crisis, seem to be weathering the storm better and have the cash to buy collapsing mid-size banks which had a lighter touch from regulators in recent years. That went well…

The last bank crisis was supposedly all about subprime loans. Investors thought that problem wouldn’t spread to the rest of bank lending – an expensive miscalculation. This new crisis starts with super-prime loans which can be just as toxic – if not more so — in a rising rate environment.

For instance, a super-prime loan for a $10M house can pose more risk to a bank's balance sheet if rates on 30-year mortgages shift from 3% to 6%, compared to $10 million in smaller defaulting loans that go into foreclosure. The actual loss after the down payment is taken into consideration may only be 0-20% while a safe-from-default 30-year fixed loan at 2.5% will not get paid off early and leaves the bank with a loan down maybe 20-40% in price if a fire sale is required. Who wants to own a 2.5% loan when new ones are at 6%?

Higher-risk bonds haven't even performed worse than investment-grade bonds, another surprising twist given the growing banking crisis. This discrepancy underscores the peculiarities of the current financial landscape, where banks can fail without triggering an immediate increase in risky debt defaults.

The Federal Reserve's recent rate hike to 5.25% from near zero just over a year ago also highlights the dangers of relying solely on monetary policy to combat inflation, especially in such a leveraged economy. A combination of tax increases, spending cuts, and a more modest rate hike could have potentially mitigated the current situation.

Despite the unfolding banking crisis and the economic uncertainty it engenders, there’s an unwarranted level of optimism in the stock market. Bargain hunting in stocks is not a good plan from these levels. Instead, investors might consider enjoying the more than 5% yields in safe T-bills while they last. There will likely come a point when the Fed will have to lower rates to shore up the real estate market and the banking industry. If not, we may find ourselves with just a few giant banks standing.

In conclusion, April 2023 has been a month of mixed signals. Despite the turbulence in the banking sector, the rest of the market has shown a degree of resilience. However, the current landscape underscores the need for a more balanced approach in dealing with inflation and for caution in the face of a highly leveraged economy. As we navigate these uncertain times, our portfolios remain diversified and primed to adapt to changing market conditions.

The strong recovery in bonds and stocks from the lows of 2022 that continued into January came to an abrupt halt in February. Bonds are now essentially flat for the year while the stock market gains, which almost broke 10%, have been cut in half. The hardest-hit stocks of last year have rebounded far more than 10% from their lows (but are still down far more than the broader market). This reversal of stocks and bonds puts a balanced portfolio up around 2–3% for the year. International stocks are holding up a bit better, though emerging markets were hit hard in February. With rates going back up, the U.S. dollar is recovering losses from the past few months, also weighing on our international funds.

Our Conservative portfolio declined 3.74% while our Aggressive portfolio declined 4.13%. Benchmark Vanguard funds for February 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 2.44%; Vanguard Total Bond Index (VBMFX), down 2.55%; Vanguard Developed Mkts Index (VTMGX), down 3.40%; Vanguard Emerging Mkts Index (VEIEX), down 6.27%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.20%.

The weight of double-digit drops in Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) as well as 3–7% hits to our bond funds pulled our portfolios down more than the benchmarks in February, leaving us barely above water for the year, while the S&P 500 is up 3.56% in 2023.

Our only winners were short funds last month. Of the hundred-plus fund categories available to investors, only short-term bonds and bank loans were up at all—and both under 1%. Some of our losses were after big run-ups in January, notably Vanguard Communication ETF (VOX), which was down 4.07% yet still up over 10% for the year. Our recently added LeatherBack L/S Alt. Yld. (LBAY) dove 5.73% and is down about as much for the year. The fund is somewhat similar to a fund we use in our managed accounts, Vanguard Market Neutral, and owns stocks while having short positions in some of the market's formerly highest flyers—questionable recent IPOs and trendy innovation stocks. These formerly hot stocks were down sharply last year but rebounded into the deep double digits in January, leading this fund to fall. The king of all future stocks, Tesla, has almost doubled since the bottom last year.

Recently added NightShares 2000 (NIWM) was down 5.88% for the month and is slated for removal from our portfolios. Unfortunately, this historical anomaly-based ETF hasn't come close to living up to the promise of an interesting risk–reward tradeoff by avoiding stocks during the day (the fund owns stock futures overnight). Most historical patterns end after investors catch on—but this one was early enough to seem workable.

Rounding out our weakness was the Euro slipping back down, sending Invesco CurrencyShares Euro (FXE) down 2.64%. Meanwhile, cryptocurrencies are in their own half-baked resurgence after the crash last year, sending Proshares Short Bitcoin (BITI) down 1.14% after a brutal January for this inverse Bitcoin fund. Surprisingly, the trouble keeps coming to companies in the crypto or digital currency area, from regulatory to more recently a run on a crypto-friendly bank. The Crypto faithful—or rather deluded—seem happy just hoarding the digital tokens and don't care if an actual business other than gambling comes to fruition after around a decade. This is not how the Internet and smartphone went down, disproving the theory that crypto is the next major innovation to take off and change lives and make a fortune “for the brave,” to misquote a recent commercial for crypto gambling by a famous actor.

It looked like the worst was behind the bond market, but rates have gone back up to roughly 4% for 10-year government bonds, sending mortgages back up toward 7%. While inflation is slowing (so far), it is definitely not falling fast enough to encourage the Federal Reserve to stop raising rates, much less lower rates as was the expectation a few months ago, which can risk inflation rising anew. T bills now pay around 5%, which is looking more attractive by the day. The main downside is that rates will go back down during the next mini-crisis. This will leave you at near 0% for who knows how long while stocks take off, keeping investors in the same uncomfortable position of early 2022—earn low yields or buy pricy stocks.

The economy is still hot. More of a surprise, the housing market hasn’t adjusted to reflect the new reality of near 7% mortgages. More of a mystery is how the commercial office market is hanging in there with the twin problems of rising rates and low occupancy in our new work-from-home reality.

High-risk debt hasn't tanked any harder than investment-grade bonds since the expectation is that the economy will remain strong enough (and inflation high enough) to allow the issuers of all the questionable debt to remain solvent. While the actual path to rising defaults could be slow, the realization defaults that could be coming can hit prices fast.

Nobody knows where inflation is going here or abroad. There is a “good news is bad news” game going on: strong economic data can hurt the market as investors speculate that it will lead the Fed to send rates too high, causing a financial calamity. The worst fund category last month was precious metals, down over 12% after a strong start to the year. Typically this area does best during rising inflation fears and falls as these fears subside. The worst thing for gold is a hawkish Fed raising rates to 6%, while a gold bug that holds no-yield gold then is faced with deflation caused by the Fed's high rates.

We're eventually going to find out if this inflation boomlet is a blip just like the years after WW2, in which case raising rates high is a bad move, or if it is the beginning of a new era of '70s-style economic stagnation and stubbornly high inflation.

Raising rates is a dangerous game because it takes time for the economy to slow down, and—by then—asset prices may have crashed. The safer move would be to raise taxes and cut spending and run a budget surplus, similar to post-WW2, to get the excess money out of the system. Today is more like the early '80s—there is no political will to remove money from voters’ hands, so we have to see what Fed rate hikes do.