April’s upward move in stocks fizzled in May with a 1.15% drop in US stocks. Foreign stocks slipped 2.83% after rising sharply in April. In recent days the market took another dive with a sharp pullback on June 1st. The main fear seems to be a newly slowing economy, but we’re sticking to our take that newly sliding home prices are the real trouble spot. Stocks can’t go in a different direction from home prices forever.

Investors were just starting to get optimistic about stocks as the market’s upward trajectory stalled. The government bond market – which even the world’s largest bond fund manager Bill Gross says is a loser bet – was a winner again as interest rates defied predictions and headed downward. The total bond market delivered a 1.3% return along the lines of our government bond fund American Century Government Bond (CPTNX), which itself didn’t keep pace with longer term government bonds.

The great fear is interest rates are going to spike ‘any day now’ if for no other reason (and they have lots of other reasons) than the Federal Reserve is going to stop buying government bonds with essentially money made out of thin air this month (the much noted end of ‘QE2’ or the second quantitative easing program by the Federal Reserve). This seems like sound logic but interest rates are going in exactly the opposite direction of the consensus prediction. Popularity can ruin a good idea. We’re sticking with our government bond funds for now.

Our Conservative portfolio was up 0.57% in May; our Aggressive portfolio was up 0.14%. Benchmark Vanguard index funds for May: Vanguard 500 Index (VFINX): -1.15%, Vanguard Total Bond Market (VBMFX): 1.29%, Vanguard International Index (VTMGX): -2.83%. In general we had a good month compared to the markets, with many funds outperforming benchmarks. Both our model portfolios are ahead of the S&P 500 over the last three months (at a significantly lower risk level) and if June continues the way it has started our one year Aggressive portfolio returns should pass that of the market.

The best stock fund categories in May were healthcare, up about 2.1%, funds that short, up 1.4%, real estate up 1.3%, and utilities up about 0.4%. Conservative stocks like consumer staples did well. Energy and natural resource stocks were at the bottom, both with 4.2% drops, followed by European stock funds down around 3% and financial sector funds down just under 2.9%. Emerging markets were next down almost 2.8%. At the top of the bond list were long term government bonds, up 3.56% and long term California municipal bonds up, 2.31%. And it seems like only yesterday there was mass panic about California debt. We’re still waiting for the predicted mass defaults. Apparently investors aren’t waiting - they have been bailing on muni debt for about a half year with no break.

Our Long/Short fund PowerShares DB Commodity Double Short (DEE) soared 10.39% in May, better than the S&P 500 by 11.5%. Of course this is after many months of terrible returns. This fund has proven to offer good protection when the economy seems to be week but has minimal long term investing merits on its own.

Vanguard Telecom Services ETF (VOX) climbed 3.70% for the month, better than the S&P 500 by 4.8% as investors clamored into lower risk stocks.

Health Care Select SPDR (XLV) rose 2.47% for similar reasons. This sort of outperformance can lead us to eventually get out of these categories.

Our alternative fund, PowerShares DB US Dollar Index (UUP), climbed 1.86% in May, better than the S&P 500 by 3.0% as the US dollar staged a brief rise after investors panicked about commodities and some foreign investments.

American Century Utility Income (BULIX) increased 1.12%, better than the S&P 500 by 2.3%.

Jensen Value J (JNVSX) was up 0.27% for the month, a decent outperformance over the market - but Jensen funds tend to do better in weak markets.  

Our International Diversified fund UMB Scout Worldwide (UMBWX) fell -3.08% in May, slightly worse than international indexes.

Vanguard European ETF (VGK) fell -2.84% last month as European stocks were near the bottom of fund categories. Concern over slow economic growth and Greece troubles circled the region like buzzards over an injured wildebeest. 

Royce Financial Services Fund (RYFSX) fell -2.01% in May, worse than the S&P 500 by -0.9%. Our take is financial stocks are going to get hit hard if home prices slide anew. We’re still in because this category remains out of favor and a major real estate slide is a long shot (so far).

Our International Diversified fund Scout International Discovery (UMBDX) fell -1.98% in May, a slight improvement to foreign stocks in general and not bad for a more aggressive and smaller cap foreign fund.

With an almost perfectly flat S&P 500 in March, you’d almost think the month was a dull one on Wall Street. Hardly. By the middle of the month the S&P 500 was down about 8% from the close in February, largely due to a massive natural and manmade disaster in Japan (a market that itself was down almost 20% from the levels in February). Though Japan only partially rebounded, the S&P 500 ended the month back where it started.

Benchmark Vanguard index funds for March:  500 Index (VFINX) up 0.03%, Total Bond Market (VBMFX) down -0.01%, International Index (VTMGX) down: -2.59%. Our Conservative portfolio was up 0.23% while our Aggressive portfolio gained 1.76%. The Aggressive Portfolio was among our best outperformance of the global bond and stock market in quite a while – largely attributed to a strong showing in utilities, telecom, healthcare, and smaller cap stocks

The United States in general was were you wanted to invest in March, with top areas being healthcare and smaller cap stocks, though energy related stocks also did well. The best area overall was emerging markets with their complete lack of Japanese stocks, climbing about 5% in contrast to international indexes that were down 2.6%.

Technology stocks, which have led the markets over much of the rebound, were tepid. Bonds were flat across the board with Emerging Markets bonds doing the best and inflation protected bonds rebounding.

In portfolio fund action last month:

• Vanguard Telecom Services ETF (VOX) climbed 3.72% in March, beating than the S&P 500 by 3.7%.
• Small Cap Growth fund Janus Triton T (JATTX) rose 3.53% in March while even smaller cap Satuit Capital Micro Cap (SATMX) was up 2.75% in March.
• Health Care Select SPDR (XLV) climbed 1.79%, similar to American Century Utility Income (BULIX), which delivered 1.77% for the month - another strong category relative to the broad stock market.
• Scout International Discovery (UMBDX) increased 1.21% in March, far more than the over 2% slide in international stocks, due partially to a decent chunk of the fund being invested in smaller cap and emerging markets and a slightly lower than typical Japan stock allocation.
• Our Large Cap Growth fund PRIMECAP Odyssey Growth (POGRX) increased 0.92%, better than the S&P 500 by 0.9%.
• With oil talking off along with many commodities our Long/Short fund PowerShares DB Commodity Dble (DEE) sank -8.00% in March. 
• The US dollar wasn’t as strong as we’d expect with global problems. Our alternative fund PowerShares DB US Dollar Index (UUP) fell -1.36% in March, worse than the S&P 500 by -1.4%.
• Without any Japan stocks, Vanguard European ETF (VGK) fell just -1.03% last month, better than most international funds or an international index.
• Parnassus Equity Income (PRBLX) slipped -0.65% in March, worse than the S&P 500 by -0.7%.
• Large Cap Growth fund PRIMECAP Odyssey Stock (POSKX) slipped -0.60% in March, worse than the S&P 500 by -0.6%, which is odd because our more aggressive PRIMECAP Odyssey Growth (POGRX) stock fund was up for the month. One reason for the gap is Odyssey Growth is a little more smaller cap oriented and smaller cap stocks did well last month.

The year started strong for stocks while bonds were stuck in the mud, the mud being rising long term rates and fears of future municipal bond defaults. The more stocks go up and bonds go down the better deal bonds become compared to stocks.

Benchmark Vanguard 500 (VFINX) fund rose 2.36% in January while foreign stocks as measured by the iShares MSCI EAFE Index ETF (EFA) were up 2.09%. Our Conservative portfolio was up 0.91% and our Aggressive portfolio gained 1.36%.

Strong areas in January included energy funds, up around 5%, followed by technology funds which gained 3.3%. Real estate rebounded, and larger cap international markets in Europe beat the U.S. Emerging markets were weak, with the typical fund in this area down about 3.25%. Latin America-focused funds slid 5.3% - an outlier in a month where other foreign stocks were strong.

• Our best showing relative to the index again was from our mortgage bond fund Doubleline Total Return Bond (DLTNX) which climbed 2.30% in January, ahead of our bond market index fund benchmark by 2.2%
• Blend fund Parnassus Equity Income (PRBLX) climbed 3.69% in January, better than the S&P 500 index fund benchmark by 1.3%
• Large Cap Value fund Homestead Value Fund (HOVLX) climbed 3.60% in January.
• Vanguard Short-Term Bond ETF (BSV) rose 0.92% for the month, better than the bond market index fund benchmark by 0.8%, while investment grade bond fund Metropolitan West Total Return (MWTRX)< increased 0.74% last month. Junk bonds did well and this fund has some higher risk corporate debt.
• Unfortunatly we also had some funds underperform the market in January. Our Vanguard Telecom Services ETF (VOX) fell -1.63% in January, 4% worse than our S&P 500 index fund benchmark.
• PowerShares DB US Dollar Index (UUP) fell -1.54% in January.
• Satuit Capital Micro Cap (SATMX) increased 0.34% in January, worse than the an S&P 500 index fund by -2.0% while Sector: Healthcare fund Health Care Select SPDR (XLV) increased just 0.57% in January.

Before we get to our regular monthly performance review, we want to update you on the year-end capital gains distribution estimates for our portfolio funds.

As longer term followers of our portfolios know, we review the year-end tax distribution estimates for our funds around this time to aid in any year-end tax planning. In the case of large year-end distribution, it can make sense to hold off buying a fund until the distribution is paid, particularly with high tax rate short term capital gains. Sometimes it can make sense to sell before the distribution and buy a different fund.

A good place to start in this somewhat complicated issue is to read what we have written in the past on year-end distributions. This article has links to more of our articles about year-end taxes.  Keep in mind that dodging year-end tax distributions doesn’t matter with IRA accounts.

So far about 80% of our funds have made estimates and there are no significant year-end distributions to report. All the funds appear to be making distributions of less than 2% of the fund price ($200 on a $10,000 investment) and most of that will be at low-tax long-term capital gains rates. Given the status of tax rates going forward, realizing long term gains at low rates is not a bad idea anyway. All other things being equal, this means you will be selling the fund at a lower price in the future (fund prices fall to reflect the distribution) which could mean paying lower taxes if rates are higher on gains at that time. Of course, check with your tax professional for specific advice.

The below table shows the funds we own that are known to be paying distributions this year, but keep in mind these estimates can change (that’s why they’re called estimates)..We are still waiting on reports from SATMX and HOVLX and will note the estimates for those funds when we get them.

In general you can ignore ETFs when it comes to year-end tax distributions except in some strange cases (notably with inverse funds that use leverage). Our investing style tends to favor funds that will not be paying big year-end dividends as we focus on out of favor funds with little hot money. The record date is the date on which, if you own the fund, you’ll own the taxable year-end distribution.

In November, our Conservative portfolio was down -1.12% while our Aggressive portfolio fell -0.14%. The benchmark Vanguard 500 (VFINX) fund was unchanged for the month while Vanguard Total Bond Index (VBMFX) was down -0.57%. Foreign stocks as measured by the iShares MSCI EAFE Index ETF (EFA) were fell -4.82% in November.

Greater exposure  to bonds and foreign stocks with larger stakes in safer stock sectors and value oriented stocks hurt returns of the Conservative Portfolio relative to the S&P 500, while the Aggressive Portfolio benefited more from riskier smaller cap stocks doing well. The Conservative Portfolio is a bit more diversified that the Aggressive Portfolio, which is notable because it is possible the types of funds investors add to diversify and to lower risk may underperform less diversified, US stock heavy portfolios over the next few years.

The best performing stock fund categories last month were energy, up 4.8%, small growth, up 4.1%, precious metals, up 4.0%, and Japan, up 3.5% (in stark contrast to the drop in other foreign markets). The worst performing stock categories were European funds, down -5.6%, foreign down about 4% (with value-oriented funds doing worse than growth funds), Asian funds down 2.8%, and telecom funds down 2.7%.

The US dollar was strong in November, despite fears that recent Federal Reserve actions to create more money will cause inflation and pummel the dollar. The rising dollar helped sink foreign funds – the place most investors have been putting their money lately (as we noted a few weeks ago). Apparently the troubles in Europe didn’t go away as counties like Greece, Ireland, and Spain are back in regular circulation in the financial press.

The only real scare in the U.S. was in the municipal bond market. Late in November prices plunged on many muni bond funds, making them among the worst performers for the month, down in the 3 to 4% range (though many of these funds fell more than this amount in just a few days). Unlike the last crash in muni bonds, which was much more severe, we aren’t swooping in to pick these ‘bargains’ up just yet. Most of this municipal bond mini crash was related to longer term interest rates moving up, and many muni bond funds have longer durations than taxable bond funds. Long term government bond funds fell nearly 2% in November, explaining much of the decline in munis. Frankly municipal bonds have become a little too popular with investors over the last year as a place to find great deals. We’re more likely to move into longer term federal government bonds if rates keep heading up.

As for our specific holdings:

• PowerShares DB US Dollar Index (UUP) rose 5.05% in November, better than the an S&P 500 index fund by 5.1%.
• Satuit Capital Micro Cap (SATMX) climbed 4.01%, beating the S&P 500 index fund by 4.0%
• Our long/short fund PowerShares DB Commodity Dble (DEE) gained 1.53% last month, better than the S&P 500 index fund by 1.5%. Commodities finally took a small tumble on worries about global growth.
• Royce Financial Services (RYFSX) increased 1.16% in November, better than the an S&P 500 index fund by 1.2%
• Mortgage Bond focused Doubleline Total Return Bond (DLTNX) increased 0.20% in November, better than the bond market index fund by 0.8%.
• Our Large Cap Growth fund PRIMECAP Odyssey Stock (POSKX) increased 0.52% for the month, 0.5% ahead of the S&P 500 index fund
• Vanguard Short-Term Bond ETF (BSV) slipped -0.40% still better than the bond market index fund by 0.2% because interest rates went up hurting longer term bond funds more.
• Vanguard European ETF (VGK) sank -7.81% in November, worse than the an S&P 500 index fund by -7.8%.
• Our international diversified fund Scout International Discovery (UMBDX) fell -3.30% last month, worse than the an S&P 500 index fund by -3.3% (though better than the foreign stock index).
• UMB Scout Worldwide (UMBWX) dropped -3.09% in November, worse than the an S&P 500 index fund by -3.1% (but again better than many foreign funds).
• Health Care Select SPDR (XLV) fell -2.89% in November, 2.9% worse that the S&P 500 Index fund.
• American Century Utility Income (BULIX) fell -1.86% in November, worse than the an S&P 500 index fund by -1.9%.

In September, our Conservative portfolio was up 3.7% while our Aggressive portfolio was up 6.5%. This compares to an 8.92% return on the Vanguard 500 (VFINX) fund and a -0.01% return for the Vanguard Total Bond Index (VBMFX).

The strongest stock categories in September where technology funds, which gained 13%, and small cap growth, up 12.8%. Japan, utilities, and real estate posted more modest gains, up 7%, 4.7%, and 4.4% respectively. Strong bond areas included emerging market bond funds, up 3.2% and high yield (junk) bonds, up 2.9%.

Good Month:

• Our Large cap growth fund PRIMECAP Odyssey Growth (POGRX) soared 12.54% in September, beating the S&P 500 index fund by 3.6%
• Small cap growth Janus Triton T (JATTX) shot up 12.32% in September, outpacing S&P 500 index fund by 3.4%
• Europe fund Vanguard European ETF (VGK) scored another big month with a 11.26% jump in September.
• Blend fund Jensen Value J (JNVSX) did well for a relatively conservative fund with a 11.21% return last month.
• International diversified fund UMB Scout Worldwide (UMBWX) also posted a big return, up 10.61% in September partially on US dollar weakness.
• Sector: financial services fund Royce Financial Services Fund (RYFSX) also moved sharply higher last month, up 10.27% in September.
• Mortgage bond fund Doubleline Total Return Bond (DLTNX) climbed 1.78% in September, 1.8% better than the bond market index. Higher risk bonds in general are on an upswing.

Bad Month:

• Our Long/Short fund PowerShares DB Commodity Dble (DEE) sank -13.87% in September, worse than the S&P 500 index fund by a whopping -22.8%. We fully expect this fund to perform poorly when stocks are doing well, unless the commodity crash starts anew. This small stake (just 2% of the Aggressive portfolio) is primarily a hedge against economic calamity and a speculation on commodities cooling.
• Utilities fund American Century Utility Income (BULIX) rose 5.54% in September, 3.4% worse than the S&P 500 index, after a strong run since we added it a few months ago.
• Our blend fund Parnassus Equity Income (PRBLX) rose 8.52% in September, which underperformed the S&P 500 index fund by 0.4%.
• Our Government bond fund American Century Government Bond (CPTNX) slipped 0.12% last month as investors favored corporate and higher risk debt in September.