May was a strange month in the market. U.S. Stocks were strong – the S&P 500 was up just over 2%. Essentially everything else was down. Foreign major markets and emerging markets sunk around 3% - with the sharpest drop in Japan down almost 8% (albeit after a 50%+ move up in recent months). 

In such a market our stock heavy portfolio did better than our safer portfolio. Our Conservative portfolio fell 2.06%. With too much in bonds and forging markets, our Aggressive portfolio dropped 0.33% - good compared to many global balanced portfolios but bad compared to the S&P 500. Benchmark Vanguard index funds for May: Vanguard 500 Index (VFINX) up 2.33%, Vanguard Total Bond Market (VBMFX) down  1.71%, Vanguard International Index (VTMGX) down  3.00%. Vanguard Emerging Markets Stock Index (VEIEX) down  3.73%.

More interesting was the bond and what can be called the near-bond market. Interest rates jumped, creating fears the end of falling rates is finally here. This took the entire bond market down almost 2% with a bit more damage to longer-term bonds (notably government bonds) which dropped almost 7%. High yield bonds, which are sensitive to interest rates but also to rising stocks and an improving economy, were down around a half percent. 

The over-exuberance in emerging market bonds, noted here back in October 2012 came to a screeching halt, with a near 5% drop in May – a rare performance divergence from high-credit-risk U.S. junk bonds. 

In recent months money has gotten awfully tired of negative real returns in cash, money markets, and CDs, and has been inching back into riskier assets – but not ‘really’ risky assets. These near-bonds – high dividend utilities and REITs among them – took a severe beating last month. Utilities were down just shy of 6%, closely followed by real estate-oriented funds. Technology funds – a land far far away from the safety and yield seeking investor – were up almost 5%. 

Another odd area to slip recently is this new fad of ‘low volatility’ stocks – basically owning stocks that don’t’ swing wildly like biotech stocks or Google. These ‘safe’ stocks (Proctor and Gamble, McDonalds, etc.) fell in May (as many of the now-popular ETFs in this area - iShares MSCI USA Min Volatility USMV and PowerShares S&P 500 Low Volatility SPLV - show), while the entire stock market rose; showing once again that popularity breads underperformance no matter what the past performance tells you. Too bad, all the papers have just started talking about the miraculous high returns of lower-risk stocks over the past few decades.

Wow. The S&P 500 and the Dow both reached record highs last month, each breaking previous marks set in 2007. Don’t hold your breath for a new NASDAQ record though – that’s a solid 10-20 years off (and maybe even longer than that if adjusting for inflation). 

Considering how poorly bonds and foreign markets did, the Powerfund Portfolios had a pretty good month.  Our Conservative portfolio gained 1.85% in March. Our Aggressive portfolio was up 2.40%. Benchmark Vanguard index funds for March: Vanguard 500 Index (VFINX) up 3.74%, Vanguard Total Bond Market (VBMFX) down 0.71%, Vanguard International Index (VTMGX) up 1.48%; Vanguard Emerging Markets Stock Index (VEIEX) down 1.57%.

U.S. markets continue to beat foreign markets, most notably now in five-year returns (which are now solidly positive given some of 2007-‘08 market slide is not included). The average U.S. non sector 100% stock mutual fund is up almost 7% per year over the last half decade while the average foreign fund is down slightly. That’s a big performance gap – wiping out a good chunk of massive outperformance of foreign markets over U.S. markets over the first half of the 2000s (though most foreign markets still have the 10-year edge performance wise). 

Unfortunately most investors got into foreign markets after the initial rise, just in time for the underperformance. At this point the only thing stopping us from increasing our foreign stake significantly is that these fund investors haven’t yet bailed out – strange given the long losing streak.  

The growth in U.S. stocks should start to slow into the next few years unless we get some faster expansion in the economy. Companies have squeezed about all they can from low interest rates and cost cutting. Company-wide bottom line profit growth is going to have to come from top line revenue growth at this point. 

Investors can expect returns somewhere in the 6% per year range from these levels (including dividends, before fees) over the next decade or so. To get to double digits will require a slide that can be bought into (or irrational roaring stock valuations like we saw in the 1990s).

One hot area abroad was Japan, carrying iShares MSCI Japan (EWJ) up 5.78%. Inflation might be in the future for Japan – which is actually good news for a Japanese economy that has been in the doldrums for more than a decade. The falling Yen is also helping.  

Our worst performing stock fund, not including our inverse commodity pick, was Vanguard European ETF (VGK) as Europe falls into new problems, partially related to the trouble in Cyprus. 

Longer term interest rates drifted up during all the good economic news, hurting our longer term bond funds.

Onward and upward. With a 5%+ jump in January alone it seems this market can’t be stopped, even though all the well-reported problems facing the global investor are only (at best) partially solved. 

All this upside is starting to attract attention. Investors are warming to stock funds again. This tends to happen shortly before market dips, and if bonds continue to slide as stocks rise we would expect to cut back on equities and shift a little more to debt, but currently stocks are still more appealing valuation-wise than bonds are.

Bonds (and bond funds) are doing badly as interest rates rise. While it is good to see rates rise if it is from genuine economic strength, the recent recovery in housing can’t handle significantly higher interest rates because higher interest rates also mean higher mortgage payments. Bond funds were mostly down (except for riskier bonds which posted a 1.3% gain). Investors are scared of rates going up and are leaving government and more investment grade bonds in favor of higher risk debt. 

With our long-term bond stakes (which fall harder than the bond market in general when rates rise) we were not as close as we’d like to the market this month, though considering how weak international markets and especially emerging markets are compared to the U.S., we can’t complain too much.

Our Conservative portfolio gained 1.88% in January. Our Aggressive portfolio rose 3.71%.

Benchmark Vanguard index funds for January: Vanguard 500 Index (VFINX) up 5.18%, Vanguard Total Bond Market (VBMFX) down 0.71%, Vanguard International Index (VTMGX) up 4.44%, Vanguard Emerging Markets Stock Index (VEIEX) up 0.61%.

In general our value-oriented U.S. funds all beat the S&P 500. Our hedges slid as commodities rose on expectations of continued economic strength. Our longer term higher grade bond funds dipped with the bond market though our funds with more credit risk like (DLTNX and MWTRX) did well.

Value oriented U.S. stock funds performed best in January for non-sector funds. Abroad, markets were up as well, though not as much as domestic markets. Energy sector funds were the hottest fund category with an 8% return, followed by healthcare with a 7.6% gain. Financials were third best, up 6.5%. We are in healthcare and financials which helped offset the drag of bonds in both portfolios.

One poor sector of note is precious metals funds (which we do not own). Down near 8% for the month and 25% for the one year, these funds are also down 1.7% annualized over five years. Imagine how crummy these funds are going to do when gold begins to slip. Gold mining…often a bad business in both good AND bad times.

Slowly but surely the Powerfund Portfolios are inching up on the S&P 500’s double-digit 2012 return. Competing against the S&P is a challenge because the portfolios are almost always at a lower risk profile because of our allocation to bonds. Even when we are closer heavily allocated to stocks and light on bonds (usually after big slides in the market) we are more diversified than the S&P 500. We also have to burden of higher fund fees than the low fee index benchmark fund. We also include dividends in the S&P 500’s returns, which gives the benchmark an additional boost.

Year to date (through the end of November) we are up 8.09% in the Conservative Powerfund Portfolio and 13.23% in the Aggressive Powerfund Portfolio. The benchmark Vanguard 500 (VFINX) fund has gained 14.79% since January 1st. For a back-of-the-envelope risk comparison, when the S&P 500 was down 6.02% in May – the worst month of 2012 - we were down 1.11% in Conservative and 3.73% in Aggressive.

In November, the Conservative Portfolio gained 0.57% and the Aggressive Portfolio gained 0.51%. The benchmark Vanguard 500 (VFINX) fund delivered a 0.56% return for the month while Vanguard Total Bond Index (VBMFX) was up 0.19%. Foreign stocks (as measured by Vanguard Tax-Managed International [VTMGX]) were up 2.43%. Emerging market stocks (as measured by Vanguard Emerging Markets Stock Index [VEIEX]) were up 1.33%.

Foreign markets are picking up. Surprisingly, developed markets are beating emerging markets (usually higher risk emerging markets outperform older, slower-growth foreign markets). The Powerfund Portfolios are currently invested in such developed foreign markets and have been largely out of emerging markets, though this could change if this performance gap continues and money leaves emerging markets.

Japan led the developed-market pack pushing iShares MSCI Japan Index (EWJ) to our top spot for the month, up 2.98%. Conversely, emerging market Latin America is one of the few categories down over the last 12 months, three years, and five years – thought the 10 year return is still tops due to major outperformance in the early 2000s. Note emerging market funds have attracted over one hundred billion dollars in recent years while U.S. stock funds have seen net outflows. U.S. markets have outperformed foreign and emerging markets over the last five years.

Among the worst sectors last month, and over the last three, was utilities, dragging our holding BULIX down 3.06% last month. There may be some early movement out of dividend-focused stocks into more growth oriented stocks, perhaps related to the upcoming dividend tax increases. Telecom stocks with their higher dividends also underperformed last month, sending VOX down 0.78%. More likely the inflows to utilities in recent months is leading to underperformance. 

In bonds, low yields are starting to weigh on returns of the bond market index, which all of our bond funds beat last month. Government bonds and longer term bonds did well relative to the bond index.

2012 is turning out to be a good year for stocks and bonds. With September’s 2.58% increase in the S&P 500 equities are up just over 16% since Jan 1. The YTD total bond market fund is up 4% through the end of September. This in the face of on-again-off-again Euro death spiral news and a domestic economy that, while not stalling, is sputtering or at least misfiring outside of technology.

Our Conservative Powerfund Portfolio was up 0.71%. Our Aggressive portfolio was up 2.37%. Benchmark Vanguard index funds for September: Vanguard 500 Index (VFINX) up 2.58%, Vanguard Total Bond Market (VBMFX) up 0.11%, Vanguard International Index (VTMGX) up 2.82%, Vanguard Emerging Markets Stock Index (VEIEX) up 5.32%. 

One reason for the hot month is attractive valuations - stocks are still below peak levels seen before the last crash. Another factor is probably the Federal Reserve's continued monetary support, delivering a boost while the Federal Government remains gridlocked.

The Fed’s money creation to buy primarily mortgage bonds is keeping interest rates in general at ultra low levels, boosting after-debt income to households and corporations alike. All this money magic (some would say mischief) without much inflation. This may sound counter to prevailing logic, but if you can essentially make money out of thin air and not cause inflation, why the heck wouldn’t you do it? 

Somebody must be getting richer from those billions of new bucks being pumped into the economy each week. That somebody is basically asset holders as all this cash is making investments go up. The Fed creates what some call, high level money. They don’t just add $100 to everyone’s checking account. The spending benefits to economy are indirect, or trickle down, from the bond buying schemes of the Fed. 

Yet much of the money still fears stocks and is favoring bonds and bond funds. We’re not quite ready to throw in the towel on most bond funds, but there are certainly some oddities brewing, notably in foreign bond markets. Emerging market bond funds had another great month, up around 2%. The five year annualized return is not about 9% - ahead of every bond and stock category except long term treasuries. The 10 year and 15 year returns are equally awesome at just shy of double digit annualized. We get it; rates are way down, pushing bond prices up. The additional kicker is that emerging market bonds were a scary out of favor area back in the late 1990s when investors were all about US growth stocks. 

Where this leaves us today though is with emerging market bonds yielding barely more than already low-yielding U.S. corporate bonds. J.P. Morgan USD Emerging Markets Bond Fund (EMB) yields 3.52% after fees. For about the same duration (interest rate sensitivity) and better credit rating iBoxx $ Investment Grade Corporate Bond Fund (LQD) sports a 2.9% yield (though the fees are lower here so the pre-fee yield of EMB is a little higher). 

That doesn’t seem like much reward to EMB owners considering the fund’s top five holdings are debt from the Philippines, Peru, and Brazil, Indonesia, and Uruguay. Top credit profile Johnson & Johnson stock yields the same 3.5%, and it’s (for now) taxed much more favorably.

The strongest areas in September were precious metals funds, up about 14% on renewed fears Fed money making will be good for gold prices. Emerging markets in general were strong, up 4.4% lead by India-focused funds up over 13%. Funds that invest in healthcare stocks were the best U.S. sector, up 4.67%.

Powerfund holdings in September from best to worst, compared to benchmark index funds: