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August 2022 Performance Review

September 7, 2022

The rebound in stocks that started in mid-June ended in mid-August, and we’re almost back to square one – a bear market. The rebound was strong – a near 20% move up, but the drop is looking just as fast. As of September 6, the S&P 500 with dividends is down around 16.8% for the year, while the bond market is down a more surprising 11% – a big hit for bonds. Foreign stocks as a group are down over 20%; some much more.

Our Conservative portfolio declined 4.06% , and our Aggressive portfolio declined 2.35%. Benchmark Vanguard funds for August 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 4.08%; Vanguard Total Bond Index (VBMFX), down 2.77%; Vanguard Developed Mkts Index (VTMGX), down 5.52%; Vanguard Emerging Mkts Index (VEIEX), up 0.23%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.61%.

Our Aggressive portfolio is down 11.37% for the year, which compares fairly well to the stock market, particularly foreign markets. For reference, at the end of August the global balanced Vanguard STAR was down 16.81% year to date. Our Conservative portfolio had a poor month and is now down 16% for the year under the weight of foreign stocks and longer-term bonds, both down in the 20%–30% range. That said, most low-credit-risk bonds likely can’t fall that much more from here, unlike stocks, which could easily drop another 20%+ if the Fed has to engineer a recession.

Some of our safer stock funds were the hardest hit in August. VanEck Vectors Pharma. (PPH) dropped 8%, while Franklin FTSE Germany (FLGR) fell 7.34%. Meanwhile, risky emerging market funds did okay, with Franklin FTSE Brazil (FLBR) up 6.47%, as Latin American funds were the #1 category last month of any fund types and one of only a handful of categories in positive territory in August. Our recently added or increased shorts helped our Aggressive portfolio offset losses. Proshares Short Bitcoin (BITI) was up 16.75% and Proshares Short High Yld (SJB) was up 4.28%, while UltraShort Bloom. Crude Oil (SCO) was up 8.72%. LeatherBack L/S Alt. Yld. (LBAY), which does some shorting, was down less than 1%.

What likely ended the stock rebound this summer was interest rates heading back up from the end of July. Stocks and real estate are heavily dependent on low rates. High rates cut into the profitability of companies and real estate as interest costs have to be deducted from revenues, but the more immediate problem is just relative valuation. If you can get 5% in a government bond or 4% in cash and CDs, levels we are approaching if rate increases keep up, why mess around with risky stocks?

There is a lot of focus on the troubles in Europe, but there is not enough focus on the potential troubles in our own housing market.

Europe has made a series of miscalculations that seem to be coming home to roost. Cutting back on nuclear energy because solar and wind are more popular (and don’t produce radioactive waste), magnified by the nuclear disaster in Japan, was a bad call for a region short on non-Russian energy.

Some of the sanctions seemed more designed to shame Russia and don’t do significant economic damage that could reduce the money flow into Russia that is used to finance the costly war in Ukraine. Shutting down McDonald’s doesn't hurt Russia. We took a US-owned asset that was drawing profits out and essentially gave it to Russia.

The main thing that needed to get done was lowering the price of oil and natural gas to reduce the flow of money to Russia. The West didn’t take the tough steps that would have caused a crash in oil – engineering a recession by raising taxes on energy temporarily. Instead, various states in the US reduced gas taxes or, in the case of California, are sending checks out under the guise of “inflation relief." The Federal Government just extended the pause on student loans and is planning on eliminating $10,000 of student debt per borrower.

The trouble is, these things will increase energy consumption and prices compared to doing nothing. It may seem counter-intuitive to raise prices with energy taxes, but with a supply-and-demand imbalance, the price is going to go higher anyway with the excess profits going to those that sell energy – like Russia. Since Europe already has near 10% inflation, slowing the economy down by driving energy demand down would have served two goals: reducing demand for Russian energy, and reducing inflation as any new tax would do sucking money out of the system (so long as it’s not spent on some sort of half-baked relief).

By deficit spending during high inflation, governments are kicking the can to central bankers (who don't have to face reelection) to solve the problems. We spent it, Fed; you unspend it because we don’t have the political will to take money away from crazed consumers.

The Fed has essentially three ways to reduce inflation: 1) scare people into speculating and spending less by talking about all the economic damage they are going to do; 2) raise shorter-term rates, which pushes up all sorts of consumer and business debt costs; 3) burn the trillions of newly created money they used to buy the debt that funded mortgages and PPP loans, also known as qualitative tightening or QT.

The Fed is trying #1 and #2 fairly aggressively, but #3 is next, and that is the one that scares investors the most. As it is, mortgage rates are going to head back up to 6% after a brief drop in recent weeks. If we go to 7% mortgages, in all likelihood we’ll have a recession and mini crash in real estate of 20%.

Home prices are as high as the last bubble, adjusting for incomes and payments. The Fed is likely aware of this and is scared to get too aggressive and would likely prefer inflation to drift down over a few years than risk a collapse in the real estate market. The best thing going for real estate and stocks now is the high inflation as rents and earnings are going up with everything else – rationalizing current high prices. If inflation runs at 8% a year for a few more years, and stocks and real estate prices remain the same, they will both be bargains, especially if mortgages remain at lower rates than inflation.

It is possible the falling stock and bond market will discourage the Fed from taking more aggressive action. It is likely if the recent rebound in stocks kept up to the old highs, the Fed would already be burning the new money, which they do by selling the bonds they bought for cash then erasing that cash from the world – the opposite of QE, or quantitative easing.

Gold, commodities, and even stupid crypto have been heading down again recently, which is what would be expected if inflation had peaked and is on the way back down.

The best case is what happened post WW2 when we had fairly massive inflation that didn’t last more than a few years, unlike the 1970s. The Fed didn’t do anything, and bond investors took the hit as inflation ate away at their investment and everything else was peachy for the next few decades.

The worst case is ugly: inflation doesn't ebb and global central banks, in an effort to prevent another 1970s, takes even more aggressive action and we go right back to a 2008 style asset crash.

Stock Funds1mo %
Proshares Short Bitcoin (BITI)16.75%
ProShares UltraShort QQQ (QID)9.75%
UltraShort Bloom. Crude Oil (SCO)8.72%
Franklin FTSE Brazil (FLBR)6.47%
Proshares Short High Yld (SJB)4.28%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.23%
Franklin FTSE China (FLCH)-0.40%
LeatherBack L/S Alt. Yld. (LBAY)-0.79%
Invesco CurrencyShares Euro (FXE)-1.76%
ProShares Decline of Retail (EMTY)-2.65%
Vanguard Value Index (VTV)-2.68%
NightShares 2000 (NIWM)-2.86%
Homestead Value Fund (HOVLX)-3.07%
Vanguard Communications ETF (VOX)-3.47%
[Benchmark] Vanguard 500 Index (VFINX)-4.08%
Franklin FTSE Japan ETF (FLJP)-4.31%
Franklin FTSE South Korea (FLKR)-4.33%
Vangaurd All-World Small-Cap (VSS)-4.67%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-5.52%
Vanguard FTSE Developed Mkts. (VEA)-5.82%
Franklin FTSE Germany (FLGR)-7.34%
Vanguard FTSE Europe (VGK)-7.46%
VanEck Vectors Pharma. (PPH)-8.01%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)-0.59%
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.77%
Vangaurd L/T Treasury (VGLT)-4.46%
Vanguard Extended Duration Treasury (EDV)-5.15%
Vanguard Long-Term Bond Index ETF (BLV)-5.29%

July 2022 Performance Review

August 4, 2022

The stock market dip buying kicked in after a 20% drop (what is usually considered a bear market) driving the S&P 500 up almost 10% in July. Some of the excitement was that interest rates drifted down as inflation fears receded, sending the bond market up about 2.31% (with interest). Emerging markets were down, and the US dollar strengthened anew as our rates are quite a bit higher than other major economies, leading to inflows of money.

Our Conservative portfolio gained 1.77%, and our Aggressive portfolio gained 0.68%. Benchmark Vanguard funds for July 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 9.22%; Vanguard Total Bond Index (VBMFX), up 2.31%; Vanguard Developed Mkts Index (VTMGX), up 5.28%; Vanguard Emerging Mkts Index (VEIEX), down 0.87%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 6.08%.

The growing mentality of “the worst is behind us” is going to make it more difficult for the Federal Reserve to chip away at inflation by slowing the economy through higher rates. The Fed already achieved much by scaring speculative assets down 50-80% in crypto and so-called innovation stocks trading at sky-high valuations. Real estate even started to show signs of cooling off when mortgage rates pushed 6%. July’s market action sending interest rates back down and speculative assets back up — 20% or more in many cases — isn’t going to help lower inflation.

One problem with the “inflation is coming down soon theory so the Fed won’t have to go nuclear with rates” rosy scenario is that this indicates a weak economy. If prices stop going up with all the work at home and Covid productivity issues globally, then the consumer is tapped out and has cut demand to meet lower supply. How is that economy going to raise earnings to higher levels than the previous stock boom? The super rosy scenario model then must be that supply comes back to normal everywhere to meet still-high demand before the demand is hit too hard.

If home prices keep going up and crypto and speculative stocks get even close to levels of last year, we’re likely going to need even higher rates to stop inflation from being closer to 10% than the supposed target of 2%. It would be in everyone’s best interest if consumers cut back on spending (and we’re seeing some signs of that) and investors didn’t go back into full gambling mode. If the Fed doesn’t care about asset prices and inflation starts heading down from the current level of higher interest rates, then stocks (and real estate) will work out for investors from these levels. This is a somewhat risky proposition that doesn’t warrant significantly more money shifted to stocks at this time.

Our biggest drag in our funds last month (not including inverse funds) was China, the single worst fund category of the month out of over a hundred fund categories. Our Franklin FTSE China (FLCH) holding was down 10.44% for the month. Our recent shifts in the portfolio didn’t benefit us, and our portfolios had lackluster returns relative to the market, notably our aggressive portfolio. As the S&P 500 beat more than 90% of funds last month, this is somewhat to be expected, but our new positions didn’t do well, so far.

While the S&P 500 was way up near 10%, newly (re)added Vanguard Communication ETF (VOX) was only up 3.71% compared with the QQQ ETF up 12.55% last month. This ETF now owns some hard-hit tech names, notably a 35% combined stake in just Facebook and Google. One big difference is that the S&P 500 and QQQ have large stakes in Tesla, which is enjoying a stock resurgence back to near $1 trillion after a 50% drop from the top reversed course with a 50% increase from the bottom a few weeks ago (which still leaves the stock down 25% from the highs last year or worse than the S&P 500). Tesla now is worth more than double Facebook (META) while Facebook trades at just 13x earnings, and Google 21, compared with Tesla’s 100+.

This is how valuable perceived future growth is relative to current earnings and the possible lack of potential growth in what is still clearly a market obsessed with the future.

Speaking of the future, crypto and related stocks were up around 30% last month. This is particularly strange given that the inflation story is supposed to be behind us and we’ve seen at least a dozen significant hacks and Ponzi grade collapses in the last few months in various crypto projects and funds. This is on top of some research noting that around 80% of all crypto coins or tokens were scams that went to near zero.

One thing the Fed learned in 1929 is that kicking up interest rates doesn’t shake speculative confidence that quickly. Does it matter if rates are 1% or 5% if you think you just bought the next Apple or the digital money of the future? If you think homes can go up 10% a year forever, is a 6% mortgage expensive?

Stock Funds1mo %
[Benchmark] Vanguard 500 Index (VFINX)9.22%
Homestead Value Fund (HOVLX)6.69%
Franklin FTSE Brazil (FLBR)6.41%
Franklin FTSE Japan ETF (FLJP)6.12%
Vangaurd All-World Small-Cap (VSS)5.92%
Vanguard FTSE Developed Mkts. (VEA)5.29%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.28%
Vanguard Value Index (VTV)5.06%
Vanguard FTSE Europe (VGK)5.00%
Franklin FTSE South Korea (FLKR)4.09%
Vanguard Communications ETF (VOX)3.71%
Franklin FTSE Germany (FLGR)2.57%
LeatherBack L/S Alt. Yld. (LBAY)1.06%
VanEck Vectors Pharma. (PPH)0.40%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-0.87%
NightShares 2000 (NIWM)-1.46%
UltraShort Bloom. Crude Oil (SCO)-1.53%
Invesco CurrencyShares Euro (FXE)-2.55%
Proshares Short High Yld (SJB)-6.58%
ProShares Decline of Retail (EMTY)-7.58%
Franklin FTSE China (FLCH)-10.44%
ProShares UltraShort QQQ (QID)-22.36%
Proshares Short Bitcoin (BITI)-25.16%
Bond Funds1mo %
Vanguard Long-Term Bond Index ETF (BLV)4.44%
Vangaurd L/T Treasury (VGLT)2.62%
Vanguard Extended Duration Treasury (EDV)2.39%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.31%
iShares JP Morgan Em. Bond (LEMB)-0.20%

June 2022 Trade Alert

July 8, 2022

We made some trades in both model portfolios on June 30th, 2022. The end result was a slight increase in stock and interest rate exposure by moving from shorter-term bonds to longer-term bonds, which are more sensitive to interest rate changes. This means that a 1% increase in rates equates to a bigger drop in price. We also made some changes to our hedging to protect the portfolios from an increasingly likely drop in higher credit risk debt, aka junk bonds. There just isn't the kind of selling from funds going on to mark a great buying opportunity even with the bear market decline.

Before we get to the trade detail, here is a quick summary of June 2022 returns:

Our Conservative portfolio declined 4.77%, and our Aggressive portfolio declined 4.89%. Benchmark Vanguard funds for June 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 8.26%; Vanguard Total Bond Index (VBMFX), down 1.50%; Vanguard Developed Mkts Index (VTMGX), down 9.61%; Vanguard Emerging Mkts Index (VEIEX), down 4.43%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 6.25%.

Although it was nice falling roughly 60% as much as the S&P 500 and less than the Vanguard STAR fund, which is a total balanced portfolio of global bonds and stocks, this was still a pretty big hit for us as stocks and bonds are falling globally. We are down 9.85% for the year in our aggressive portfolio, or about half the S&P 500 drop. Our conservative portfolio at -13.93% is less impressive but is more interest rate sensitive and doesn't have offsetting short positions. Year to date, Vanguard Star Fund (VGSTX) is down 18.64% to the end of June.

The only fund category that was up in June was China region funds, which have been very weak until recently. Even hot commodity focused categories and countries like energy funds and Brazil funds have been down sharply. Gold, the supposed safe haven from global turmoil and inflation, is down about 15% from its peak a few months ago. Our only strong showing last month (other than short funds) was Franklin FTSE China (FLCH), up 8.59% and now "only" down 10.57% for the year. Compare that to Franklin FTSE Germany (FLGR), down 16.18% for the month and just under 30% for the year, and you can see how much more economic risk Europe is in than China with Russia and rising energy prices. It is unlikely China can avoid a recession in Europe and the United States, so these recent market moves are more the west catching up to the declines in China.

The reason for the turnaround in commodities-oriented investments is that the writing is on the wall and the Fed is likely going to keep raising rates until inflation starts definitely heading back toward 2%—which could take some time. Without the White House cutting spending or raising taxes, it will take high rates to suck back the maybe $10 trillion handed out globally as stimulus during COVID. It was dangerous and unnecessary for the Fed to keep buying mortgage bonds, recently sending the 30-year mortgage under 3% during what has been fast becoming another real estate bubble. The new higher mortgages could cause a real estate crash, particularly in commercial space that, in the case of offices, barely makes sense at current rent prices due to the new hybrid work schedule.

The S&P 500 is now in a bear market down around 20% for the year. Long-term bonds are down about as much, highlighting the difficulty for risk reduction with a balanced portfolio when interest rates are near zero with little room to go but up. Growth and tech areas are down around 30% or more. So far, it has been a good year to be in value stocks and cash.

Normally, this would be a good time to increase risk significantly as we did during the COVID crash in the early 2020, but this trade does not do that. We're holding out for another 10—20% drop and buying longer-term bonds while avoiding most higher credit risk bonds. It is likely we will be doing another trade in a few months if the market keeps sliding. If the Fed turns out to still be a so-called dove, inflation remains high, and short-term rates don't go much higher, we may miss a turnaround in the market, and this will be another 20% drop dip buying opportunity like during the end of 2018.

The Trades

All bonds are down this year, with longer-term bonds down around 20%. We cut back on longer-term bonds during the COVID crash, and our initial move to inflation adjusted bonds was a good call. Perhaps we got out of these bonds too soon fearing the risk of inflation expectations collapsing if the Fed got aggressive on fighting inflation, which didn't really happen yet.

Now with all rates rising rapidly, our shorter-term investment-grade mortgage bond fund is down a whopping 8.8% for the year through the end of the June. This was better than the even overall bond market down just over 10.35% and less than half the 21.40% slide in Vanguard Long-Term Bond Index ETF (BLV) a long-term bond fund that we cut back on post-COVID.

Long-term bonds have declined about the same as the S&P 500 (so far), down around 20% including dividends. Speaking of, the yield on the S&P 500 is up but still only around 1.65%, and the bond market as a whole now pays a far more healthy 3.5%. Although it is possible that interest rates will continue up to meet higher inflation, realistically the bulk of the hit to bonds is behind us, and any moves to say 4—5% will reverse when the next recession kicks probably from the higher shorter-term rates. If the Fed chooses to allow more high inflation, it is unlikely interest rates will rocket higher to say 7% just to continue to pay less than inflation—which is no great situation but still warrants owning 3—5% yielding bonds as the stock market risk is higher than bonds if the Fed overshoots.

We've discussed this poor situation in bonds since early 2020. When cash yields zero and the bond market yields less than 2%, your offsetting gains from a stock slide are essentially nil. This is why a bond and stock blend did so poorly in the early 2020 COVID crash, and this year (so far). In hindsight, when we reduced our stake in long-term and inflation adjusted bonds (for this very reason), we should have just gone to cash and not for the paltry yields in mortgage bonds. This is easy to say now, but earning zero while the Fed decides what to do isn't a great solution. It would have made more sense to own more stocks, less bonds, and more hedges.

If stocks go significantly lower from here, it is more likely that bonds will do well (not junk bonds, but investment-grade and government debt), so the benefit of a balanced portfolio will return.

NEW HOLDINGS ADDED TO BOTH PORTFOLIOS

Leatherback Long/Short Alternative Yield ETF (LBAY)

Aggressive Portfolio from 0% to 3%

Conservative Portfolio from 0% to 5%

This new fund was launched last year and broadly speaking is somewhat similar to a fund we've used off and on in client accounts, Vanguard Market Neutral (VMNFX). These funds mostly own value-type stocks and short high-flying growth stocks with questionable fundamentals like Carvana (CVNA) to name one of hundreds. This strategy can work in normal markets but is best during deflating bubbles. It is a disaster during times like 2020 and 2021 when hot bubble stocks get hotter, as you can see from the bad performance of Vanguard Market Neutral (VMNFX). We're pretty late in the deflating tech bubble game with roughly 80% declines across the board, but this strategy still offers potential for a late-stage decimation and 99% drops in many speculative tech names. VMNFX is the lower risk (less overall market exposure) and probably the better choice but has a high minimum, so we are not using it here. LBAY probably has more upside (and downside) risk. Unlike most of our holdings, we may not keep this fund for over a year, so consider it in an IRA in case there are short-term gains. Also the fund has a regular dividend payout strategy, which is basically a marketing gimmick.

Vanguard All-World Small-Cap (VSS)

Aggressive Portfolio from 0% to 9%

Conservative Portfolio from 0% to 5%

Foreign stocks are now very cheap, though they face high risks from a deep recession as many do not have secured domestic energy supplies and rely heavily on Russia. This, plus rising rates and slowing economies as well as dealing with multidecade high inflation, makes times look even rougher abroad than here. This is also why these prices should work out in the longer run. Many of these markets are almost in single-digit PE ranges, and dividend yields are more than double the United States. Small cap stocks abroad are even more out of favor probably because of the large cap index focus of most investors when investing abroad.

Proshares Short High Yield (SJB)

Aggressive Portfolio from 0% to 5%

Conservative Portfolio 0% to 7%

High-risk bonds will fall hard if the economy slides into a deep recession. Safer bonds could actually improve in price, so it is possible that we'll make money on this fund and our longer-term investment-grade bond funds. There is little risk in the short run of this fund falling significantly and losing money in investment-grade bonds, which would require the spread between low- and high-risk debt to shrink.

We don't usually have inverse funds in our Conservative portfolio, but we need protection from further troubles in the bond market. This fund is a safe way in the short run to do that. See Aggressive portfolio for more explanation.

SELL ALL IN BOTH PORTFOLIOS

Vanguard Mortgage-Backed Securities (VMBS)

Aggressive Portfolio from 20% to 0%

Conservative Portfolio 30% to 0%

While we were right to cut back on longer-term bonds and go to shorter-term safe bonds, there was still too much interest rate risk here, and we should have just stuck it out in cash or 1-year bonds. We could continue to hold this fund, but we're going to move more to long-term bonds (which have more downside risk if rates keep going up). The fund was down 8.88% for the year.

Vanguard Utilities (VPU)

Aggressive Portfolio from 10% to 0%

Conservative Portfolio from 10% to 0%

We're cutting back on lower-risk stock funds that are yield focused. These funds are attracting too much money as investors shift out of growth. This fund was down just 1.23% for the year, so it served its purpose during this bear market.

AGGRESSIVE PORTFOLIO ONLY

Overall: 62% stocks to 63% stocks, bonds from 34% to 21% (but more rate risk) alternative from 0% to 3%, and inverse 4% to 11% (largely from adding inverse junk bonds).

Click here to visit the Aggressive Portfolio's trade center.

AGGRESSIVE PORTFOLIO ADD NEW HOLDINGS

Vanguard Telecom VIPER (VOX) from 0% to 10%

We've owned this fund for years but cut it loose long ago as a too-early exit from tech bubble valuations. The issue was that the communications indexes started adding Facebook and Google, which does make sense on some level but also exposed the fund to high-risk stocks instead of the usual Verizon- and AT&T-type holdings.

Fast forward to today, and these stocks are all way down. A few days ago, this fund was down around 40% from the highs last September. Keep in mind more speculative tech names are now down 50—90% pretty much across the board. Can they go lower? Definitely, earnings are going to be a problem at even tech monopolies as ad spending from money-losing bubble-era startups gets cut in a desperate attempt to get profitable. Still, these prices are attractive, and we can add more if this isn't the bottom.

ProShares Short Bitcoin Strategy (BITI) from 0% to 2%

Too bad this inverse Bitcoin fund wasn't launched before the 70% drop in bitcoin, as we've been noting this bubble for years here. It would seem this bubble is almost fully popped, but Bitcoin, unlike say a tech index, can go far lower. This fund should do well as inflation fears disappear as the whole narrative of 0% rates is fast ending. Since there are few ways to short commodities and inflatable assets, this offers an, albeit strange, deflation bet. In many ways, sharply falling inflation is worse for stocks than high inflation and is outright deadly for real estate. That said, crypto investors have cultlike behavior and may not sell even in the face of 70% declines and crypto accounts being frozen or falling 99%.

Leatherback Long/Short Alternative Yield ETF (LBAY) from 0% to 3%

This new fund was launched last year and broadly speaking is somewhat similar to a fund we've used off and on in client accounts, Vanguard Market Neutral — VMNFX. These funds mostly own value-type stocks and short high-flying growth stocks with questionable fundamentals like Carvana (CVNA) to name one of hundreds. This strategy can work in normal markets but is best during deflating bubbles. It is a disaster during times like 2020 and 2021 when hot bubble stocks get hotter, as you can see from the bad performance of Vanguard Market Neutral Fund (VMNFX). We're pretty late in the deflating tech bubble game with roughly 80% declines across the board, but this strategy still offers potential for a late-stage decimation and 99% drops in many speculative tech names. VMNFX is the lower risk (less overall market exposure) and probably the better choice but has a high minimum, so we are not using it here. LBAY probably has more upside (and downside) risk. Unlike most of our holdings, we may not keep this fund for over a year, so consider it in an IRA in case there are short-term gains. Also the fund has a regular dividend payout strategy, which is basically a marketing gimmick.

Ultrashort Bloomberg Crude Oil (SCO) from 0% to 2%

This fund generates K-1 partnership tax paperwork, not a 1099, so it should be in an IRA. Unfortunately, there are very few ways to short commodities with ETFs or funds anymore—most are too small or too leveraged. This is too bad as the real risk now is a collapse in the economy and the new commodity bubble. Bottom line, if stocks fall another 20%, it will likely happen as oil falls back to $50. There is some risk of the Russia situation sending oil up to $150, in which case we may double down on this position. We owned a similar fund during the last great recession-era commodity crash and did well.

AGGRESSIVE PORTFOLIO REDUCE HOLDINGS

Vanguard Value Index (VTV) from 14% to 6%

The value boom relative to growth might not be over, but we don't need such a big weight here anymore. This fund was only down 9.29% for the year, or about half the S&P 500. We're not ready to get back heavy into the Vanguard Growth ETF Vanguard Growth ETF (VUG), which was down around 30.37% for the year, but perhaps soon.

AGGRESSIVE PORTFOLIO INCREASE HOLDINGS

iShares JP Morgan Em. Bond (LEMB) from 4% to 7%

We cut this fund back from 8% to 4% back in late February 2021 as it was riding high after the COVID rebound. We probably should have gone to zero like in the Conservative portfolio. Anyhoo, now that the fund is down sharply (around 15% for the year and about 25% since we cut it back) with over 7% yields, it is time to go increase the position, though there are big risks in high-yield bonds that hopefully we're covering with our new short high-yield bond ETF. There is potential to make money here when our dollar sinks from multidecade highs. In general, reaching for yield in a potentially teetering economy is a bad idea.

CONSERVATIVE PORTFOLIO ONLY

Overall: 42% stocks to 44% stocks, bonds from 48% to 32% (but more rate risk) alternative from 10% to 17%, and inverse 0% to 7% (from adding inverse junk bonds).

Click here to visit the Conservative Portfolio's trade center.

CONSERVATIVE PORTFOLIO ADD NEW HOLDINGS

NightShares 2000 (NIWM) from 0% to 5%

This new fund (launched in the last few weeks) is a bit of a gimmick based on a historical anomaly. Typically we don't like data mining to create a fund because, by the time you get around to marketing a fund, the money that has been made in this anomaly goes away—or even reverses . Many things work on paper until enough people start doing it. Sometimes such patterns work during certain markets and do the opposite during others—the Dogs of the Dow strategy where you simply focus on the highest yielding stocks in the Dow worked great, until growth stocks started to lead the market in the late 1990s (and again until recently).

That said, this anomaly may not go away for another year or so, and this strategy should be lower risk than owning a straight small cap stock fund as we did post-COVID crash. We're going to have to watch it closely for a possible sale. This fund should be tax-inefficient from constant realized short-term capital gains, so consider it in an IRA.

The fund only owns stocks (through futures) at night, in this case the small cap Russell 2000 index. The pattern has been that, if you buy stocks near the end of the market close, say 3:50 p.m., and sell the position at 9:30 a.m. when the market opens, you earn a better risk adjusted return than the market. There are hypotheses and white papers about this, which doesn't make it any more certain as a strategy for the future of course. Our theory is that it is partially the result of day traders coming into stocks in the morning often with leverage and getting out by the end of the day, artificially boosting prices in the morning, depressing them near the end of the day, and causing a generalized irrational fear of the overnight. But retail day traders have largely been destroyed since the 2021 peak in growth stocks. We'll have to watch this one closely for asset growth or the end of the era of this scheme working. There are other problems like tax inefficacy that almost require this in an IRA.

Vanguard Long-Term Treasury Index (VGLT) from 0% to 8%

Not much to explain here—as rates go up and bonds tank, we're moving into longer-term bonds that have the most upside if rates go back down, say in the next recession. The only way long-term rates go much higher from here is if the Fed stops raising short-term rates and doesn't sell off many of the bonds acquired with newly created money and essentially remains a dove. It could happen, but it is not that likely. Meanwhile, 3%+ yields are worth some risk, unlike 1%.

CONSERVATIVE PORTFOLIO INCREASE HOLDINGS

Vanguard Extended Duration Treasury (EDV) from 10% to 14%

This is the recession buster holding because the interest rate exposure is so extreme, meaning changes in interest rates lead to huge changes in the fund price. The fund does best when rates go down for safe bonds as is often the case in a recession and when inflation expectations decline. We sold some of this fund post-COVID when rates were ultralow then bought some back early in 2021 (too early as it turns out). This fund is down 28.11% YTD more than the S&P 500 and almost exactly what the Nasdaq is down from the highs. If long-term rates go up more, we'll increase our position again.

Invesco CurrencyShares Euro (FXE) from 10% to 12%

Eventually we're going to stop raising rates, and then other countries with rising inflation are going to go up and our hot dollar is going to sink back down. In the meantime—go to Europe on a trip as the Euro is around parity (1 USD — 1 Euro) with the dollar, the best deal in decades for travelers.

Vanguard Long-Term Bond Index ETF (BLV) from 8% to 10%

This has a similar explanation to new holding Vanguard Long-Term Treasury Index (VGLT), only we don't want to increase our corporate bond position that much quite yet—this fund includes government and corporate investment-grade bonds, which explains the slightly higher yield.

Franklin FTSE South Korea (FLKR) from 5% to 7%

Our last trade here was cutting back in February 2021 after a big move up (basically a double). Now with a slide of 25% YTD in 2022 and about a 36% drop since we cut back, we're increasing the position again. The fund portfolio has yields of over 3% and a P/E ratio under 10 or about half the valuations of the S&P 500—not that cheapness magically saves you from losses in a global panic or recession, but it can reduce your losses when bubbles burst, at least compared to other options.

 

Stock Funds1mo %
ProShares UltraShort QQQ (QID)16.73%
Franklin FTSE China (FLCH)8.59%
ProShares Decline of Retail (EMTY)6.19%
Invesco CurrencyShares Euro (FXE)-2.46%
VanEck Vectors Pharma. (PPH)-3.02%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.43%
Franklin FTSE Japan ETF (FLJP)-6.97%
Vanguard Value Index (VTV)-7.91%
[Benchmark] Vanguard 500 Index (VFINX)-8.26%
Homestead Value Fund (HOVLX)-8.39%
Vanguard FTSE Developed Mkts. (VEA)-9.20%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-9.61%
Vanguard FTSE Europe (VGK)-9.95%
Franklin FTSE South Korea (FLKR)-14.11%
Franklin FTSE Germany (FLGR)-16.18%
Franklin FTSE Brazil (FLBR)-19.28%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)-1.42%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.50%
Vanguard Long-Term Bond Index ETF (BLV)-3.19%
iShares JP Morgan Em. Bond (LEMB)-3.31%

May 2022 Performance Review

June 5, 2022

A late-month rebound in stocks stopped May from being as bad as April. This reversal is probably because interest rates took a break from the dramatic rise this year, a rise that has taken most bond funds down 5%—20% in value. Foreign stocks did a little better last month than the tech-heavy US market, which has been under significant pressure since this market turned south at the beginning of this year. May was a good month for our portfolios, especially relative to US markets.

Our Conservative portfolio gained 1.50%, and our Aggressive portfolio gained 2.12%. Benchmark Vanguard funds for May 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 0.18%; Vanguard Total Bond Index (VBMFX), up 0.58%; Vanguard Developed Mkts Index (VTMGX), up 1.73%; Vanguard Emerging Mkts Index (VEIEX), up 0.62%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.69%.

We're still down almost 10% in our Conservative portfolio YTD, which is a rough year compared to the 12.78% hit to the stock market. Our Aggressive portfolio is down a more respectable 5.22% for the year.

Much of the froth in the stock market around supposedly innovative stocks of the future is now gone, although many still need to go to zero like in the 2000—2002 washout. The most trendy growth stocks are now mostly down 50%—90% from highs. The Nasdaq was recently down shy of 30% year to date before the recent rebound (still down over 20% YTD). For the record, the Nasdaq was down around 40% in 2000—the year the tech bubble popped—though, from the peak in March 2000, the Nasdaq fell around 50% (and 75% top to bottom in 2002). Last month, technology-oriented funds were down about 3% and 28% for the year.

In general, stock valuations globally aren't that bad. This will likely only be a good entry point if interest rates stick around these levels and we avoid a recession. Safe bonds are now reasonably priced at roughly 3% yields. Although 3% sounds like a terrible deal with near 10% inflation, the days of almost guaranteed positive returns adjusting for inflation in safe assets are gone. One way or the other, inflation will return to sub 3%, and bonds should more or less break even with inflation. We remind you to buy your yearly allotment ($10k max per person) of Series I Savings Bonds direct from the US Treasury.

If inflation doesn't start to fall, global central banks will have to keep punishing the market—not just the stock market but the housing market. In theory, if governments raised taxes and cut spending, we'd get a balance in supply and demand, but in practice the Fed is probably going to have to raise rates higher than inflated asset prices can handle.

We're close to moving back out on the yield curve to longer-term bonds—into the fire. The next leg down in bonds will likely be high-yield junk bonds—the authentic proof a recession is around the corner. We may also increase our foreign stock allocation, though there will be no immunity from a recession by investing abroad.

All of our holdings except Vanguard Extended Duration Treasury (EDV), which was down 4.03% last month (and down 21% since added back to portfolios in February), beat the S&P 500 in May (except our short QQQ fund), which reflects how much of this slide is tied to mega-cap US growth stocks. Our top performer last month was the recently volatile Franklin FTSE Brazil (FLBR), up 7.15%. In theory, this fund will be a winner from high global commodity prices that need to come from places that are not Russia, but there is risk in any emerging market for a worldwide recession that lowers all prices. This fund would be a good holding for a soft landing economically, meaning one where central banks can ease us off high inflation without a deep recession.

Our second-best holding was Franklin FTSE Germany (FLGR), up 5.16%, rebounding off a significant drop this year. With increasing talk of cutting way back on Russian energy, Germany is in a precarious position economically now. The one that got away, energy funds are still delivering this year as oil goes ever higher on a still-hot economy with supply issues. Energy funds are the top area this year, up 45% for the year and 13% last month. Too bad we cut back a few months ago. The worst place is digital asset-oriented funds, down around 50%. Too bad they didn't make a crypto token backed by oil instead of ones supported by... another crypto (and now down 99.9%).

Other big losers for the month include real estate funds, down around 5% as rising rates and a slowing economy place risks on this area beyond making the yield less attractive. It is still unclear what is going to happen to commercial real estate if this hybrid work structure sticks because, long term, it will create a glut in office space that won't be easy to fix with lower rates, unlike the last crash in commercial real estate.

Our third best holding Vanguard Utilities (VPU), up 4.51%, is due for a cut as investors swinging out of risky growth stocks have landed on safe income stocks, and the relative value is falling fast here.

The next shoe to drop, if there is one, will be high-yield bonds, notably floating-rate debt that investors feel is safe because the yields reset with short-term rates. The trouble in this area, which we do not have direct exposure to as in floating rate or bank loan funds, is shaky as companies won't be able to make these payments if rates rise too far, especially if we get a weak economy and high short-term rates. The good news is the loan you made to me now pays 7%, not 4%. The bad news is I can't afford 7%. Defaults will go up, way up.

There is a broader issue here with our margin loan economy. With low rates below inflation and far below historical price increases in real estate and stocks, it made sense to borrow against your stocks to buy real estate or just have money to spend. Why pay tax selling stocks that should go up 5%—15% a year forever when you can borrow against this portfolio at 3%, tax-deductible? Stock-backed loans are how many tech billionaires avoid tax and finance lavish lifestyles for a long time. Recently this financial engineering has been marketed to the rich but not the island-owning rich by banks. Such securities-backed loans are everywhere on balance sheets, on top of the near trillion dollars in ordinary stock margin loans, a record.

The banking system seems secure because today's real estate loans are much safer. Low down payment adjustable rate "loser" loans to those lying about their income (No Income, No Job NINJA loans) are more or less gone from the system. Now the homes are backed by solid folks sitting on millions in stocks.

This is all fine and dandy until stocks fall 50% or more. We may never expose this weak link in the economic chain, but if we do, it could be as bad for real estate and stocks as 2008. It has been quite some time, 1929 to be exact, since excessive stock leverage has led to economic and market problems. Banks don't remember, but customers with high credit scores swimming in assets can default quickly as subprime borrowers if conditions turn very dark.

In the meantime, the Fed isn't going to be there to support a crash unless inflation cools off. The market, for the first time in 30+ years, is flying without an insurance policy.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)7.15%
Franklin FTSE Germany (FLGR)5.16%
Vanguard Utilities (VPU)4.51%
ProShares Decline of Retail (EMTY)4.28%
Vanguard FTSE Europe (VGK)2.41%
Homestead Value Fund (HOVLX)2.41%
Vanguard Value Index (VTV)2.41%
Franklin FTSE China (FLCH)2.25%
VanEck Vectors Pharma. (PPH)2.17%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.73%
Franklin FTSE Japan ETF (FLJP)1.72%
Vanguard FTSE Developed Mkts. (VEA)1.65%
Invesco CurrencyShares Euro (FXE)1.64%
Franklin FTSE South Korea (FLKR)1.42%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.62%
[Benchmark] Vanguard 500 Index (VFINX)0.18%
ProShares UltraShort QQQ (QID)-1.15%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)0.91%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.58%
iShares JP Morgan Em. Bond (LEMB)0.48%
Vanguard Long-Term Bond Index ETF (BLV)0.23%
Vanguard Extended Duration Treasury (EDV)-4.03%

April 2022 Performance Review

May 5, 2022

Ouch. Global markets are not in the mood to fight inflation, and the market reaction to the Fed press conference of May 4th only highlights the growing fear of the world of waning global monetary stimulus. Stocks and bonds were down sharply across the board in April as inflation shows no signs of abating without action — the kind that slams the economy and markets. The real story isn't the near-double-digit hit to stocks, but the near-double-digit hit to bonds. These fears are rational. Inflatable assets like commodities, real estate, and stocks often do very badly when inflation heads back down. Bonds do badly when inflation isn't in check. If both are down, then the assumption is that the higher rates in the bond market are going to "work" in cooling inflation.

Our Conservative portfolio declined 5.72%, and our Aggressive portfolio declined 5.54%. Benchmark Vanguard funds for April 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 8.72%; Vanguard Total Bond Index (VBMFX), down 3.85%; Vanguard Developed Mkts Index (VTMGX), down 6.55%; Vanguard Emerging Mkts Index (VEIEX), down 5.55%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 7.43%.

In hindsight, when we cut back on inflation-adjusted bonds (which we went into last year when rates and inflation were low), we should have just parked half the portfolio in cash instead of mortgage bonds. Like everyone, we were scared of nearing zero on cash for years waiting for higher rates or lower stock prices. Well, higher rates came fast — about as fast as the 1994 and late 1999 bond mini crash. Long-term government bonds were down about 9% in April — more than stocks — and are down around 20% for the year as of now. The good news for investors is now you can earn 3% safely. Over time, this is better than if rates remained 1%.

Before you get too scared, keep in mind the bond market isn't going to fall 50% like stocks can from here. Some ultra-long-term zero coupon government bonds may fall briefly. If bonds fall much harder, it will be brief, at least for government bonds. In such a crisis, the Fed would switch to money creation and bond buying again (and hasn't even started selling off the bonds purchased with new money during the COVID crash).

This is a leveraged world with sky-high asset prices based on low rates. The U.S. government can't afford our debt at 7%, and neither can anybody else. The "good" news for the government is they just inflated away 10% of the debt or maybe $2 trillion. Without almost guaranteed inflation of over 5% a year, nobody can afford to buy a high-priced home with a 7% mortgage. Sure we've had 10% mortgages "in the past," but then homes were priced at 2 times average incomes; today it is more like 4 times. In many hot real estate markets, that number is 10 times.

Current bond yields are actually not a bad deal in the long run as we will likely, hopefully, return to sub-3% inflation, and in general low default risk bonds probably won't pay more than inflation for long periods of time ever again — as we've noted here before.

Some commodity funds were up a little last month, but 99% of fund categories were down. Commodity funds won't do well if inflation heads back down and we get a recession, but they will do well if inflation remains above 4% with the economy remaining hot. The hardest hit areas included foreign stocks and growth stocks. Tech stocks are in a bear market, and technology category funds are down close to 25% for the year. As noted before, this doesn't even capture the full-on 2000 grade crash in stocks of the future or so-called innovation investments. These are now down 50% to 90%. Many will go to zero.

Our inverse Nasdaq fund is finally paying off with a 45% gain YTD. This has partially offset big losses in bonds and stocks, notably in our remaining long-term bonds and foreign stocks. Our China fund Franklin FTSE China (FLCH) is down 19.46% for the year. As proof of the pain in bonds, our Conservative portfolio is down 10.95% for the year, while our Aggressive portfolio is down just 5.54%, as opposed to the near 13% drop in the Vanguard 500 fund and a whopping 13.81% year to date drop in Vanguard Star Fund (VGSTX), which highlights the hard hit to bonds and foreign stocks this year. That's right, diversifying into bonds and foreign stocks actually increased downside in 2022, so far. Our strongest areas include VanEck Vectors Pharma. (PPH), down just 2.25% for the month and up 1.31% for the year, followed by utilities, which were basically flat for the year after Vanguard Utilities (VPU) slid 4.38% for the month.

The Federal Reserve Chairman press conference from April 4 made little sense. Initially, there was a massive spike in stocks, which (so far) abruptly reversed on April 5 during one of the wildest two-day sessions in a long time.

The Fed is in a tough spot. They probably feel that this inflation is sort of phony as it results from distortions in supply and demand and that if they react to aggressively it will cause a depression, yet they can't keep saying "transitory" and doing nothing. Imagine if the government decreed three-day weekends for workers for a year and sent bonus checks to all workers every few months. We'd have inflation. Should the Fed raise rates and cause a recession to fix it? Isn't the fix either get used to higher prices as supply and demand adjust or go back to work 5 days a week and stop sending stimulus checks (or deferring loan payments)?

The gist of the message from the first in-person Fed press conference since COVID was that the legislators aren't to blame even though they are the ones who handed out checks and encouraged working less during shutdowns. The high inflation is all the Fed's world — and the Fed will deal with it. No more Mr. Nice Rate Guy — inflation must be brought down to save the little guy. We don't work for Goldman Sachs! This strong message was followed up with fairly weak action and a near guarantee that shorter term rates won't go up that fast or that much — because we sure don't want to cause a recession to fight the worst inflation in 40 years.

The wild card to higher rates is the increasingly bizarre government support of stretched consumers and borrowers. There is no telling what a pandering state or federal government will do if mortgage rates hit 6% on a 30-year fixed rate mortgage — already well over 5%, which is a big move up from around 3% or lower just a few months ago. Perhaps we'll get checks in the mail to subsidize bigger mortgage payments for new home buyers — why not? We got oil released from the Strategic Petroleum Reserve and essentially handouts to car owners in CA and gas tax breaks in Republican states because gas prices went up. The consumer must always be coddled! Higher prices and rates won't work in slowing demand if we get subsidized for high prices.

Bottom line, in the short run, rates may go up more to counter the Fed's lazy response to inflation caused by Congress. Bond holders are getting nervous. This will start hitting stocks harder than bonds, though we could see a bond fund rush to the exists (again). Ultimately we'll slide into a recession if rates get too high, and bonds will go back up with rates down as inflation fears morph into deflation fears (again).

If the federal government isn't going to address inflation caused by supply and demand imbalances, the Fed needs to raise short-term rates faster than planned to prevent long-term rates from going up too fast — basically reassuring bond investors that inflation is going away so you can safely buy a 3% government bond. Losing the long end means 6% mortgages and recession.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)29.91%
ProShares Decline of Retail (EMTY)0.99%
VanEck Vectors Pharma. (PPH)-2.25%
Vanguard Utilities (VPU)-4.38%
Invesco CurrencyShares Euro (FXE)-4.72%
Vanguard Value Index (VTV)-4.79%
Franklin FTSE China (FLCH)-5.17%
Homestead Value Fund (HOVLX)-5.51%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-5.55%
Vanguard FTSE Europe (VGK)-6.25%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-6.55%
Franklin FTSE South Korea (FLKR)-6.62%
Vanguard FTSE Developed Mkts. (VEA)-6.79%
Franklin FTSE Japan ETF (FLJP)-7.86%
Franklin FTSE Germany (FLGR)-8.01%
[Benchmark] Vanguard 500 Index (VFINX)-8.72%
Franklin FTSE Brazil (FLBR)-13.21%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-3.59%
[Benchmark] Vanguard Total Bond Index (VBMFX)-3.85%
iShares JP Morgan Em. Bond (LEMB)-4.71%
Vanguard Long-Term Bond Index ETF (BLV)-9.49%
Vanguard Extended Duration Treasury (EDV)-12.57%

March 2022 Performance Review

April 5, 2022

U.S. stocks shrugged off their slide of over 10% this year with a strong 3.7% jump in the S&P 500 in March. The Nasdaq, heavy in growth stocks, rebounded from a short-lived 20% drop — technically in bear market territory. At the end of March the S&P 500 was down just under 5% for the year, and the Nasdaq just under 10%. With bonds and foreign stocks mostly down around 6% for the year, diversifying isn't helping.

Our Conservative portfolio declined 0.55% and our Aggressive portfolio gained 0.80%. Benchmark Vanguard funds performed as follows in March 2022: Vanguard 500 Index Fund (VFINX), up 3.70%; Vanguard Total Bond Index (VBMFX), down 2.83%; Vanguard Developed Mkts Index (VTMGX), up 0.30%; Vanguard Emerging Mkts Index (VEIEX), down 2.47%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.23%.

Our Aggressive portfolio is down just 1.74% for the year but our Conservative portfolio is down 5.55%, more in line with benchmarks. Longer-term bonds have been the biggest drag on our Conservative portfolio, with drops of 13.06% and 10.47% over the past three months in Vanguard Long-Term Bond Index ETF (BLV) and Vanguard Extended Duration Treasury (EDV) respectively, though our shorter-term bond funds, such as the recently added Vanguard Mortgage-Backed Securities (VMBS), are also down just under 5% for the year. Other losers include Franklin FTSE Germany (FLGR), down 13.4% in 2022; Germany, as a major destination for Russian oil and natural gas, is the EU country with perhaps the most financial risk from the war in Ukraine. There is almost no scenario in which Russia sees a major impact on inflows of money without Germany seeing an energy shortage. It is akin to our own problems with the OPEC embargo in the 1970s.

Besides shorts, support to our Aggressive portfolio was provided by VanEck Vectors Pharma. (PPH) and Vanguard Utilities (VPU). Safer stocks are doing well, especially relative to speculative growth stocks with little or no earnings. Such former high flyers are down on average by over 50% from their 2021 highs, though they have rebounded during the latest dip buying.

The one-month return for Franklin FTSE Brazil (FLBR) was an astounding 14.38%, completing a 34.78% return for the quarter. Brazil has already benefited from high energy and commodity prices in recent months, and is a likely source for many exports currently coming from Russia. Our biggest misses this year are exiting inflation-adjusted bonds and energy stocks too soon, though inflation-adjusted bond funds are still down for the year — just not quite as much as other bond funds.

Energy funds are the top performing category for the year, up about 33%. China funds are down for the month and year, and our Franklin FTSE China (FLCH) holding was down 9.69% for the month and 15.07% for the year. There has been a huge rebound in Chinese stocks in recent weeks, off a much lower low. It appears that the Chinese government is easing its crackdown on tech company power. We may increase this stake. There are lingering fears that a property bubble has already popped, and that the damage will not be repaired easily. Many stocks face delisting in the U.S. market for not meeting our regulatory standards. There is also the possibility of China siding with Russia sufficiently to trigger significant sanctions. But it is unlikely that companies will write off business in China — a huge part of the supply chain and of many companies' revenues — as quickly as the West did with Russia, a much smaller economy with limited business ties to the U.S.

If this recent dip buying is to work out, we will have to see higher interest rates not crushing the economy into recession, as has often happened. The yield curve recently went negative, meaning that two-year Treasury bonds now yield more than ten-year bonds. This usually happens when a recession is near and investors don't expect inflation or growth in a recession. We're already seeing 30-year mortgage rates approach 5%, which is a big increase from recent months at around 3%. So far this hasn't hit the roaring real estate market.

In a real speculative mania economy, Federal Reserve rate hikes don't hit the speculation right away, only the 'real' economy. If investors are convinced they will make 10% a year or more in stocks, real estate, and now crypto, then whether it costs 3% or 6% or 9% is not that relevant, so long as loans are available. There are already signs that banks are loosening lending requirements, adjusting to the higher mortgage payments. We're not quite at negative amortization NINJA loans (no income no job) but we're moving slowly in that direction.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)14.38%
Vanguard Utilities (VPU)9.78%
VanEck Vectors Pharma. (PPH)5.35%
[Benchmark] Vanguard 500 Index (VFINX)3.70%
Vanguard Value Index (VTV)3.28%
Homestead Value Fund (HOVLX)1.72%
Vanguard FTSE Developed Mkts. (VEA)0.68%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.30%
Vanguard FTSE Europe (VGK)0.16%
Franklin FTSE South Korea (FLKR)-1.32%
Invesco CurrencyShares Euro (FXE)-1.41%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.47%
Franklin FTSE Japan ETF (FLJP)-2.50%
Franklin FTSE Germany (FLGR)-2.56%
ProShares Decline of Retail (EMTY)-4.38%
Franklin FTSE China (FLCH)-9.69%
ProShares UltraShort QQQ (QID)-10.92%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)-2.38%
Vanguard Mortgage-Backed Securities (VMBS)-2.47%
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.83%
Vanguard Long-Term Bond Index ETF (BLV)-3.98%
Vanguard Extended Duration Treasury (EDV)-6.38%

February 2022 Performance Review

March 8, 2022

Just when it felt like we were exiting one global economic problem, we're confronted with another. Within just a few days, the Russia—Ukraine war has already decimated Russian stocks and now seems to be spreading into other markets, notably Germany, the most strongly linked economically to Russia, likely foreshadowing economic problems to come. The S&P 500 was down 3%, and with the action in early March is down over 10% for the year, joining other markets and indexes already down that much or more. Bonds were weak as well, particularly foreign and emerging markets bonds. Once again, bonds offer no offsetting gains from falling stocks, just less downside. Such is the dilemma of low rates.

Our Conservative portfolio declined 2.21% and our Aggressive portfolio declined 1.63%. Benchmark Vanguard fund movements in February 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 2.99%; Vanguard Total Bond Index (VBMFX), down 1.13%; Vanguard Developed Mkts Index (VTMGX), down 2.47%; Vanguard Emerging Mkts Index (VEIEX), down 4.27%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 2.42%.

Our Aggressive portfolio did well against the market for the month and is doing well for the year. But our Conservative portfolio, without the benefit of shorts and with too much exposure to Europe, given the rising risks in the region, fell by almost as much as the broader market. At the end of February the S&P 500 was down 8.02% in 2022 (with dividends, as measured by the Vanguard 500 fund) while our Conservative portfolio was down 5.03% and our Aggressive portfolio just 2.52%.

It was a month in which we wished we still owned our energy fund, as that fund category's 20% return was about the only strong area in the global market last month. The second best area was Latin American stocks, which we do own. They are an energy and commodity play of sorts, though this region is falling with emerging markets now.

Energy is at the center of this crisis. Europe is not really capable of getting by without Russian oil and gas, given the tight supplies and strong economies globally. Everything that goes in and out of Russia seems liable to attract punishing sanctions, except its primary source of revenues — energy. Limited sanctions won't keep Russian commodities off the market entirely anyway, they'll just be sold to different buyers.

Our dollar has climbed, as it often does during a crisis, which hurts foreign investment returns. This will eventually create even better opportunities to invest abroad. It is possible we will cut back on European stocks and increase our foreign stock stakes in coming weeks or months, but the timing will be a crapshoot. China was weak, as were emerging market stocks and bonds. Nobody knows where economic contagion will appear.

It is noteworthy that the last time Russia had a financial crisis, in 1998, it wasn't the hit to the Russian stock market that was the issue so much as hedge funds that were gambling on risky debt. It ultimately led to a bailout of sorts, orchestrated by the Federal Reserve, and a brief but significant slide in stocks worldwide.

Unlike Russia, which has been shoring up its finances for years in preparation for trouble (apparently of its own making), America and Europe borrowed and spent to support the last crisis. The notion of supporting another recession this soon is not in the financial cards. Another wild card is the Federal Reserve, which until a few weeks ago was going to raise interest rates to end the worst inflation in decades. Before this latest slide, U.S. stocks were actually rebounding on hopes we don't get a rate increase because of the Russia situation, as if slightly lower rates can magically support stocks regardless of serious global economic problems. The case can be made that rates should go higher, to slow the economy and inflation and drive energy and commodity prices down.

There will be some opportunities but this problem is likely to get worse before it gets better. Most high-flying, low earnings growth stocks were already down around 50% from their peaks last year. This new trouble is driving down the rest of the global market.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)6.70%
Franklin FTSE Brazil (FLBR)3.94%
ProShares Decline of Retail (EMTY)3.08%
Franklin FTSE South Korea (FLKR)0.45%
VanEck Vectors Pharma. (PPH)-0.18%
Invesco CurrencyShares Euro (FXE)-0.32%
Vanguard Value Index (VTV)-1.15%
Franklin FTSE Japan ETF (FLJP)-1.44%
Homestead Value Fund (HOVLX)-1.86%
Vanguard Utilities (VPU)-1.87%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.47%
Vanguard FTSE Developed Mkts. (VEA)-2.65%
[Benchmark] Vanguard 500 Index (VFINX)-2.99%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.27%
Vanguard FTSE Europe (VGK)-5.29%
Franklin FTSE China (FLCH)-5.81%
Franklin FTSE Germany (FLGR)-8.86%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-1.08%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.13%
Vanguard Extended Duration Treasury (EDV)-2.52%
Vanguard Long-Term Bond Index ETF (BLV)-2.60%
iShares JP Morgan Em. Bond (LEMB)-4.23%

January 2022 Performance Review

February 2, 2022

In January, the roughly 50% crash in higher flying mania stocks that started earlier in 2021 finally spread to the rest of the stock market — the market with earnings. The current explanation is the market doesn't like all this talk of raising rates to trim inflation as it could work a little too well and hurt the economy, stock market, and real estate. The bond market took a hit as rates rose in anticipation of less support from the Federal Reserve. Foreign markets were a little stronger as their relative value may have offered some support to suddenly high-valuation-shy investors.

Our Conservative portfolio declined 2.88%, and our Aggressive portfolio declined 0.90%. Benchmark Vanguard funds for January 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 5.18%; Vanguard Total Bond Index (VBMFX), down 2.19%; Vanguard Developed Mkts Index (VTMGX), down 3.95%; Vanguard Emerging Mkts Index (VEIEX), up 0.42%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 4.35%.

From the peak in early January, the US market promptly fell 10% — a correction by Wall Street's overly positive terminology. Then, as fast as the slide, the dip buying kicked in, with a roughly 5% move up in the last few days of the month through the end of February 1, leaving the S&P 500 down only 5.18% for the month.

Our returns relative to the benchmarks were good, though giving energy funds the heave-ho late last year was a tad early as we missed the hottest fund category of January. Recently sold Vanguard Energy (VDE) was up 17.48% last month. All was not lost. Latin America funds, themselves heavily influenced by rising commodity prices, were one of the few hot areas in January, taking our holding Franklin FTSE Brazil (FLBR) up 13.37%.

About 90% of fund categories were down in January, but the hardest hit areas were growth stocks, with only modest losses in value stocks. While emerging markets as a group were basically flat to slightly down, single regions differed wildly. South Korea dragged on our returns by underperforming the S&P 500, but in general all our other funds beat the falling US market.

Bonds were hit hard, which largely explains why our Conservative portfolio fell harder than our Aggressive portfolio. This is the danger of relying too heavily on bonds for safety in a high-inflation, low-interest rate environment. Normally in a 10% down period for stocks, bonds would do well offsetting losses. Now rising rates are dragging on stocks. Our riskier bond fund, iShares JP Morgan Em. Bond (LEMB), was our only bond fund with a positive return (0.66%). The rest sank with Vanguard Extended Duration Treasury (EDV) at the bottom of the barrel, down 4.73%, followed by Vanguard Long-Term Bond Index ETF (BLV) down 4.27% — around double the broader bond market's drop.

Inflation-protected bond funds took a hit as well, down around 1.7% for the month, as the expectation is that the Fed will raise rates and it will likely put a lid on inflation, giving investors no more protection than regular bond funds at this point — only with the potential for greater losses than non-inflation-adjusted government bonds if the Fed is a little too successful in stamping out inflation. Our recent move out of inflation-adjusted bonds into regular safe bonds offered no benefits here, as both sank in January.

Even with the 50% crush in speculative stocks including SPACS, meme stocks, Crypto, so-called stonks, and earning-less stocks of the future, the broader stock market is hardly a cheap market. In theory, high inflation and low rates mean stocks have a shot of growing into their elevated valuations.

Nobody knows where rates and inflation are going to go, but a soft landing may not be on the cards this time around. Covid stimulus spending is fast waning, and sub-3% mortgage rates are in the rear-view mirror.

There could also be a wealth effect loss from all the trillions of paper wealth that has disappeared in a few months. A 5% hit to your 401k isn't going to drag the economy down. A 50% hit to your Robinhood account may. We're all lucky this speculative bubble didn't get any bigger than it did last year or we'd be looking at a repeat of 2008, when falling real estate took the whole kit and caboodle down with it.

This 10% drop may just be another in the long line of dips to buy. Historically, when an underlying bubble is popping, 10% is only the beginning of a bigger drop. 2000 dot com bubble, 2007 real estate and bubble, 2021 crypto and crappo stocks? We'll see.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)17.39%
Franklin FTSE Brazil (FLBR)13.37%
ProShares Decline of Retail (EMTY)8.92%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.42%
Franklin FTSE China (FLCH)-0.16%
Vanguard Value Index (VTV)-1.07%
Invesco CurrencyShares Euro (FXE)-1.30%
VanEck Vectors Pharma. (PPH)-1.44%
Franklin FTSE Germany (FLGR)-2.47%
Homestead Value Fund (HOVLX)-2.94%
Vanguard Utilities (VPU)-3.36%
Vanguard FTSE Europe (VGK)-3.58%
Vanguard FTSE Developed Mkts. (VEA)-3.86%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.95%
Franklin FTSE Japan ETF (FLJP)-4.02%
[Benchmark] Vanguard 500 Index (VFINX)-5.18%
Franklin FTSE South Korea (FLKR)-7.78%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)0.66%
Vanguard Mortgage-Backed Securities (VMBS)-1.48%
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.19%
Vanguard Long-Term Bond Index ETF (BLV)-4.27%
Vanguard Extended Duration Treasury (EDV)-4.73%

December 2021 Performance Review

January 5, 2022

If ever there was a year for American exceptionalism, it was 2021. Our vaccines, if not our deployment, were at the top of the global heap (with some help from Germany). Our stock market as measured by the S&P 500 delivered a remarkable 28%+ return for the year, while the main foreign developed markets index was up around 8%.

For the year, we were up 10.85% in our Conservative portfolio, and 11.35% in our Aggressive portfolio — solid, except when you look at the US stock market, and then it was a miss, even adjusting for the 1.86% negative return in the total bond index fund for 2021. The slightly riskier Vanguard Balanced Index (VBINX) was up 14.09% in 2021, to get an idea where a 60/40 stocks to bonds with no foreign stocks portfolio did last year. And yes, we're in the sort of overheated market where you have to apologize for double-digit returns not measuring up…

For the last month of the year, our Conservative portfolio gained 2.29% , and our Aggressive portfolio gained 2.97%. Benchmark Vanguard funds for December 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 4.48%; Vanguard Total Bond Index (VBMFX), down 0.41%; Vanguard Developed Mkts Index (VTMGX), up 4.80%; Vanguard Emerging Mkts Index (VEIEX), up 1.74%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.37%.

This was one of the few years recently that we beat Vanguard Star Fund (VGSTX), a global balanced fund. At around 63% stocks (and about two thirds of that US stocks), it is a little riskier than our portfolios these days but is the main benchmark we try to beat. When the market is down, like in 2018, we fell by less. This fund was up 9.65% in 2021.

We beat this top low-cost global fund partially because we had some areas that outperformed the S&P 500 in 2021, like our recently sold Vanguard Energy (VDE) and Vanguard Small-Cap Value (VBR), and our bond picks were inflation adjusted and had gains while the overall bond market was down. We also rebalanced out of some hot areas like Franklin FTSE South Korea (FLKR) early in the year, booking some gains in areas that weakened as the year progressed.

In December some of our holdings took off, boosting our relative return, notably Vanguard Utilities (VPU) which was up a whopping (for utilities stocks) 9.42% for the month right after we increased the allocation from 5% to 10%. VanEck Vectors Pharma. (PPH) was up 7.74% in what seems to be a move out of trendy, no-earnings stocks to safe, higher-dividend, older stocks.

Current holdings that did well in 2021 were Homestead Value Fund (HOVLX) and Vanguard Value Index (VTV), both value funds up just shy of the S&P 500 with 25% and 28.6% returns, respectively. The only fund categories to beat the S&P 500 in 2021 were energy (#1) and other natural resources, real estate, small cap value, and financials. Our recently sold Vanguard Energy (VDE) holding was up 56% for the year. Losers in 2021 were most emerging markets; notably, Latin America and China. Our own holdings Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) were down 17.12% and 20.81% for the year, with a basically flat year for emerging markets.

Foreign stocks — notably China, the # 2 largest economy — started to sink after the big rebound off the Covid-crash lows while US stocks remained on the up and up. Much of this was currency fluctuations, but in general, foreign stocks have wildly underperformed US markets even looking at currency-hedged funds; notably, emerging markets.

When you buy a total global stock index fund today, you get 60% US stocks. You won't see a foreign name in the top 10 anymore. Toyota (TM) — Japan's biggest company by market value and the world's number one car company by earnings — is just 0.28% of the fund. You'll get almost 5x as much Tesla (TSLA) investing in the fund.

To Tesla stock fans, this matters as much as noting Nokia was once the top cell phone company and Apple was overpriced at the dawn of the iPhone. I'd reply to that by noting that Apple wasn't worth over a trillion dollars at the dawn of the iPhone as Tesla is today; it was worth $100 billion.

The future now costs 10x as much.

Back before this long run of foreign stock underperformance, half the global top 10 was foreign, mostly companies in China. In 1999, before the big run in foreign stocks, it was 80% US stocks.

US GDP is just 25% of global GDP. This doesn't mean the US should be at 25% of global market cap for many reasons; notably, more of our economy is publicly traded, and the tech monopolies are located here. But as recently as 2007, after a few years of foreign stocks outperforming the US (much because our dollar sank in value), our stocks were down to around 30% of global market cap. We are double that now.

We are at, or near, the high of our stock market valuation relative to foreign markets.

Historically, US vs foreign stocks go through periods of performance gaps, much of it currency related, and as a sort of reversion to the mean we're probably due for a few years of underperformance relative to foreign stocks. But then, we were due for this at the beginning of this year and yet… here we are with another year of US dominance of global stock markets. Note that we can get back to normal levels by just falling more than foreign stocks in the next bear market.

It is hard to escape the feeling we are in a new grand bubble that has lifted most assets, including essentially all US stocks, bonds, and real estate. Unlike in past slides, there may be no safe resting place for (the money of) the wicked.

To get an idea how bad things could get, imagine if we returned to the valuations of the bottom of the 2007—09 crash, perhaps the last time stocks were cheap since the early 1990s.

To use the so-called Buffett Indicator, which is the ratio of total stock market value to our GDP, we got down to 50% of stock market value to GDP in early 2009 (from a then bubble high of around 150% in early 2000).

Today, stocks are worth $53 trillion, and our current GDP probably hit around $24 trillion by the end of 2021 (largely "thanks" to inflation), or 220% of GDP. If we had a crash back to 50% of GDP or $12 trillion it would be a — gulp — roughly 80% fall.

There are many things different today that could "stop" such a calamity; notably, low rates and a central bank willing to create money and buy assets well before we get to such levels. Frankly, we don't do Great Depressions anymore — the government steps in to make the bets whole again.

One unfortunate side effect is everybody who's anybody knows the support is there and is willing to pay a higher price for assets because the downside seems limited. All this does is create the need for greater support the next time around. It is unclear what will fix housing the next time it crashes — 0% mortgages?

Perhaps the end game is inflation, currently running near double-digit levels in the longest period of "transitory" in history.

Inflation can support inflated asset prices by inflating the fundamentals: rents, earnings, etc. Even the non-inflation-adjusted GDP can inflate, as it has this year. Inflation will also do wonders for our deeply indebted government now committed to running deficits in good times and bad, assuming rates stay below inflation, and why wouldn't they if the Fed creates money to buy bonds and push yields down?

The trouble with this inflationary soft landing is it requires — to quote now infamous 1920s economist Irving Fisher — a permanently high plateau in stocks. We have to freeze prices here and let the fundamentals inflate. But that won't happen. We'll turn 10% inflation into a reason to pay 30% more for homes and stocks as the only game in town to protect you from the inflation.

Our American exceptionalism is hiding questionable longer-term fundamentals. We're in an asset bubble where everything collectible has unlimited upside and little downside. We can't get the economy growing faster than other slow-growth economies globally without permanent fiscal and monetary stimulus. We could never balance the budget without causing a depression, much less reduce the trillions the central bank created to support the economy by removing money from the system without causing deflation and asset price collapse.

There is always the chance we get another near 30% year because bubbles can always get bigger. It is possible we inflate our way out of this one at great long-term cost to safety-seeking investors in cash and lower risk bonds. This risk is the main reason we're not 80% cash and bonds now. We can't safely earn 5% in a 3% inflation world; we can only safely earn 1% in a 7% inflation world.

There are already signs this grand bubble era is ending. Trendy stocks trading on stories without earnings are already crashing — most are now in a bear market. Formerly hot funds like ARK Innovation ETF (ARKK) were down 23% last year, while the rest of the stock market went to the moon.

The real question for 2022 is whether this bear market in hype eventually drags the whole economy and market down, sort of like the dot com crash of 2000. Can the economy handle losing trillions in paper value in digital collectibles?

Or has the stock market become a metaverse, and it no longer matters what assets were valued at in the real world of the past?

Stock Funds1mo %
Vanguard Utilities (VPU)9.42%
VanEck Vectors Pharma. (PPH)7.74%
Vanguard Value Index (VTV)6.94%
Homestead Value Fund (HOVLX)5.38%
Vanguard FTSE Europe (VGK)5.17%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)4.80%
Franklin FTSE South Korea (FLKR)4.67%
[Benchmark] Vanguard 500 Index (VFINX)4.48%
Vanguard FTSE Developed Mkts. (VEA)4.29%
Franklin FTSE Brazil (FLBR)3.93%
Franklin FTSE Germany (FLGR)2.84%
Franklin FTSE Japan ETF (FLJP)2.14%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.74%
Invesco CurrencyShares Euro (FXE)0.25%
Franklin FTSE China (FLCH)-2.48%
ProShares Decline of Retail (EMTY)-2.68%
ProShares UltraShort QQQ (QID)-3.69%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)0.57%
Vanguard Mortgage-Backed Securities (VMBS)-0.18%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.41%
Vanguard Long-Term Bond Index ETF (BLV)-1.08%
Vanguard Extended Duration Treasury (EDV)-2.71%

November 2021 Performance Review

December 4, 2021

The market is too hot, so we cut back on stocks in late November until things cool off a little. This exuberance has mostly been in US growth stocks lately as global stocks, notably emerging markets, have been weak. We lost money last month relative to the US market, which we don't normally do in a down market, as did Vanguard's global balanced fund. The S&P 500, largely weighed to big-cap growth stocks, barely declined at all. If early December is any indication, beating the S&P 500 in December will be easier.

Our Conservative portfolio declined 1.74%, and our Aggressive portfolio declined 2.43%. Benchmark Vanguard funds for November 2021 were as follows: Vanguard 500 Index Fund (VFINX), down 0.70%; Vanguard Total Bond Index (VBMFX), up 0.33%; Vanguard Developed Mkts Index (VTMGX), down 4.72%; Vanguard Emerging Mkts Index (VEIEX), down 3.22%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 2.02%.

There was no stock fund category that beat the S&P 500 last month, which is almost impossible, especially in a down market. Somehow the mix of stocks in the popular index was the only way to not lose more than about 1% last month.

On November 26, we decreased our official stock allocation from 67% to 62% in our Aggressive Portfolio and 45% to 42% in our Conservative Portfolio.

Given the current world of low rates and high inflation, it may seem like a very stupid time to cut back on stocks and buy more bonds. It seems especially stupid to cut back on inflation-adjusted bonds in favor of bonds that will almost definitely lose to inflation this year.

While we certainly could be early (it won't be the first time) and miss more gains in stocks, when something seems like the clear way to go, it often is not. It was just last year that we added energy fund Vanguard Energy (VDE) and inflation-oriented bonds when everybody thought the oil business was done and oil futures were even near zero at one point of the negativity. When we bought Vanguard S/T Infl. Protect. (VTIP), our bond fund that owns TIPS or Treasury Inflation-Protected Securities, inflation expectations were for under 1% a year over the next five years.

The dumbest thing we did in hindsight was not buy more risky stocks - because that seemed dumb during a global economic shutdown.

Now that we made almost 10% in these safe bonds while non-inflation-adjusted government bonds went down a few percent and inflation expectations now are for 3%-ish a year, it is time to switch back to regular non-inflation-adjusted bonds. The more likely situation is the Fed tries to clip inflation and sends it down, along with stocks. Investors have been flocking to TIPS funds, which is another bad sign. If you want inflation protection beyond what your house, social security checks, and likely stocks offer, consider buying Series I Savings Bonds direct from the Treasury as they have a better risk-reward now because you won't "lose" 10% if inflation expectations go back down as can happen here.

We moved out of energy and small-cap stocks as the gains have been strong and the risk of downside too great. We sold all the inflation-adjusted bonds in favor of low-risk and low-return government mortgages in a new holding, Vanguard Mortgage-Backed Securities (VMBS), which barely yields over 1% but is a nice place to sit out the next down stock market, which could take inflation-adjusted bond funds down 5%-10%. We'll get some inflation protection, if this is even needed, from utilities stocks through Vanguard Utilities (VPU), which we increased.

Our new allocation to Japan through Franklin FTSE Japan ETF (FLJP) is more to own a safer stock market that has some relative value now compared to hotter markets, as well as potential currency-positive action. There will be a time soon when we will double down on China, which has been weak of late, but we don't want to be too early.

You can view a table detailing changes to the Aggressive portfolio by clicking here.

Changes to the Conservative Portfolio can be seen here.

We also rebalanced where appropriate to get closer to the official allocation percentages.

Stock Funds1mo %
[Benchmark] Vanguard 500 Index (VFINX)-0.70%
Franklin FTSE Brazil (FLBR)-1.52%
Vanguard Utilities (VPU)-1.59%
Invesco CurrencyShares Euro (FXE)-1.99%
Homestead Value Fund (HOVLX)-2.70%
Vanguard Value Index (VTV)-3.04%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.22%
ProShares UltraShort QQQ (QID)-4.58%
Vanguard FTSE Developed Mkts. (VEA)-4.64%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-4.72%
Vanguard FTSE Europe (VGK)-4.89%
VanEck Vectors Pharma. (PPH)-4.95%
ProShares Decline of Retail (EMTY)-5.16%
Franklin FTSE South Korea (FLKR)-5.17%
Franklin FTSE China (FLCH)-5.49%
Franklin FTSE Germany (FLGR)-6.45%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)3.60%
Vanguard Long-Term Bond Index ETF (BLV)1.10%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.33%
iShares JP Morgan Em. Bond (LEMB)-3.20%

October 2021 Performance Review

November 7, 2021

The brief weakness in stocks in September didn't last. Any fears of inflation, stagflation, global supply shortages, and the like melted away as the S&P 500, with dividends, returned 7%, leading to a 5.13% three-month return and a whopping 24% year-to-date.

This 7% pop was higher than the monthly return of 95%+ of fund categories (stock and bond). It was also enough to get us to Dow 36,000, only 22 years after the then-famous bubble book of the same name was published in 1999. For the record, it took about 15 years for investors to break even on NASDAQ stocks purchased in early 2000 and about a decade for S&P 500 investors to be safely above the levels of the bubble top (the brief move above 2000 levels in the S&P 500 didn't hold through the 2007-09 crash).

Our Conservative portfolio gained 3.19%, and our Aggressive portfolio gained 3.16%. Benchmark Vanguard funds for October 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 7.00%; Vanguard Total Bond Index (VBMFX), down 0.03%; Vanguard Developed Mkts Index (VTMGX), up 3.15%; Vanguard Emerging Mkts Index (VEIEX), up 1.11%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.33%.

Our low allocation to US growth stocks was covered by strong returns in energy, utilities, and bonds, leading us to roughly match the Vanguard global balanced fund, which is a bit riskier (more stocks and downside) than our portfolios. It was another late 1990s market, where everything sort of underperforms large-cap growth stocks in the US.

Our hottest fund was Vanguard Energy (VDE), up 11.21%, as inflation fears and consumer demand drive oil ever higher. It is almost unbelievable to consider that a little over a year ago we had zero-dollar oil futures and everyone writing oil off as yesterday's investment destined to go the way of the buggy whip, and ultimately the internal combustion engine.

Now there are gas lines in the UK and Russia is sitting in the natural resource catbird seat. While the good times could last, this area needs to get cut back from portfolios, if for nothing else, as protection from the next economic slowdown, which will break the oil markets again. Vanguard Utilities (VPU) was up 6.01% as interest rates drifted back down, boosting the value of this high dividend income area. Everything else we owned underperformed the S&P 500, though only Brazil stood out as a big loser (not including shorting), with Franklin FTSE Brazil (FLBR) down a big 9.17% as emerging markets in general are falling out of favor, kicked off by China's ongoing troubles.

This fear of foreign emerging market risk pushed iShares JP Morgan Em. Bond (LEMB) down 1.18% during an otherwise good month for bonds that saw our Vanguard Extended Duration Treasury (EDV) holding climb 3.52% and Vanguard Long-Term Bond Index ETF (BLV) up 1.72%.

Other hot areas in October were precious metals funds, which jumped almost 10% in an otherwise terrible year where they are still down for the year - surprising to those who believe that gold is the ultimate protection against inflation.

It must be aggravating to gold bugs to finally (after waiting for so many years!) get inflation to jump significantly only to watch in horror as gold- and silver-related investments slide. To add insult to injury, the new anti-dollar investment all the youngsters can't stop blathering about - cryptocurrencies - are up big. We've read stories about the supposedly uncomfortable holiday season as families with, let's say, differing COVID policies get together, but what of breaking bread while sitting on a pile of 'precious' metal coins bought from some TV ad about Armageddon only to hear some younger family members talking about their digital currency riches?

Understandably, with interest rates below inflation, the incentive to do something is high. Low, sub-3% rates will likely be here forever, other than some brief pops, for two main reasons: too much money to invest in too few safe assets, and globally indebted governments like ours literally can't afford the payments on the debt if the rates rise to 'normal' levels.

The Fed is going to orchestrate a system to keep the economy and government functioning and that is likely going to require managing how much cash and bond investors can lose relative to inflation. Don't hate the Fed, though - they are merely picking up after our government, which won't or can't close the gap between spending and tax revenues. It is almost preposterous that the Fed may have to raise rates soon, probably crushing stocks and real estate, all to fight inflation that the government can clamp down on by raising taxes and/or cutting spending. Sadly, the fiscal response would only help our debt situation while the Fed's fix of raising rates will only worsen it by raising the government's borrowing costs.

But while low rates can and should rationalize higher asset prices, they won't prevent downside risk as panic takes over or guarantee higher returns going forward.

The main difference between now and the early 2000s Dow 36,000 book era isn't stock valuations, which are almost equally absurd as they were in 2000 (and in many cases more so). It is the lack of a safe 5% choice.

Imagine stocks double from here in the coming few years, and we get a dividend yield of below 1% across the market (currently only 1.3%, roughly where we were in 2000) and P/E ratios go to 44 from around 22 now. Or double again and get to basically Japan 1989 valuation levels. At some point, you won't beat even the negative inflation adjusted returns of safer bonds or cash over time. The same is true of real estate - there is a point, say when the rental yield doesn't even cover property taxes and maintenance, that upside is more or less limited. There is a reason Warren Buffett currently is sitting on a record $150 billion in cash..

The Japan stock market is still about 25% under the highs of over 30 years ago. When you get into bubble territory, the only way to not lose money in the longer run is if the underlying fundamentals - earnings with stocks, rents with real estate - grow and catch up to your overvaluation. Unlike Japan, we've remained a positive GDP growth country (but only in the sub-3% range annualized since the 2000 bubble) and tech earnings have caught up to the old NASDAQ price level, eventually.

The question is, can we grow the fundamentals fast enough again when we are already running massive budget deficits with little room to add more, under-tax and overspend as if in a recession, are hitting inflation levels the Fed will eventually crush, and are probably going to face rising taxes in the future? We've got other population issues that will be an increasing drag, as they have been in Europe and Japan.

For those looking too hard for investments to get away from zero, please check out "Series I Savings Bonds" directly from the U.S. Treasury's 1990s retro website. They are sold with zero yield with an inflation adjustment, so if inflation is 5% you get a 5% return in the form of the bond's value going up - a gain that can be deferred for 30 years.

These directly sold non-market-traded bonds can be superior to the inflation-adjusted bonds we already own in our portfolios and client accounts (and are now selling), which already adjusted up in value as investors' fear of future inflation grows (leaving room for a drop if we get falling inflation fears). Direct I bonds don't sell at a premium (other than a no-coupon besides an inflation adjustment - itself a sign of high demand). You will still need inflation to be higher than, say, 2% to beat regular non-inflation bonds, so while they may have no downside they can underperform other low-return investments. What you don't risk is "losing" 5% to 10% if inflation comes down fast, as can be the case in TIPS if you buy now and sell when investors aren't as fearful about future inflation.

The direct-bought bonds are limited to $10k per person per year or larger investors would be snapping them all up. It is a gift in this market. Yes, they can be sold when there are better deals in other safe assets (which may be never) or stocks (likely). The current interest rate is 7.12%, but it will drop when the government gets around to stamping out inflation, or if inflation just proves to be transitory as we are told. All those gold investors who are down for the year during our highest inflation year in decades shouldn't be jealous of cryptocurrencies, but zero-risk, zero-fee, or zero-commission inflation-adjusting bonds that guarantee to pay you the rate of inflation. They don't advertise them on TV, of course.

It is also worth noting that stock markets tend to go down soon after a rise in inflation, not so much because rising prices destroy economies at relatively low levels of inflation, but because the actions taken to fight inflation sink asset prices. This is why the transitory theory better prove right - if inflation goes away "naturally," with no major Fed action, we are far more likely to avoid another market slide.

Stock Funds1mo %
Vanguard Energy (VDE)11.21%
[Benchmark] Vanguard 500 Index (VFINX)7.00%
Vanguard Utilities (VPU)6.01%
Homestead Value Fund (HOVLX)5.82%
Vanguard Value Index (VTV)5.44%
Vanguard FTSE Europe (VGK)5.03%
Vanguard Small-Cap Value (VBR)4.56%
VanEck Vectors Pharma. (PPH)3.69%
Vanguard FTSE Developed Mkts. (VEA)3.23%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.15%
Franklin FTSE Germany (FLGR)3.12%
Franklin FTSE China (FLCH)2.43%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.11%
Invesco CurrencyShares Euro (FXE)-0.31%
Franklin FTSE South Korea (FLKR)-1.52%
ProShares Decline of Retail (EMTY)-5.65%
Franklin FTSE Brazil (FLBR)-9.17%
ProShares UltraShort QQQ (QID)-14.69%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)3.52%
Vanguard Long-Term Bond Index ETF (BLV)1.72%
Vanguard S/T Infl. Protect. (VTIP)0.70%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.03%
iShares JP Morgan Em. Bond (LEMB)-1.18%

September 2021 Performance Review

October 5, 2021

High inflation with rising energy prices was unsettling enough, but add interest rates on a move back up and it all seemed to be too much for investors to handle. In September almost all fund categories were down, except energy, commodities, and Japan.

Our Conservative portfolio declined 2.36% and our Aggressive portfolio declined 2.27%. Benchmark Vanguard fund results for September 2021 were as follows: Vanguard 500 Index Fund (VFINX), down 4.65%; Vanguard Total Bond Index (VBMFX), down 0.91%; Vanguard Developed Mkts Index (VTMGX), down 3.43%; Vanguard Emerging Mkts Index (VEIEX), down 3.37%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 2.96%.

Our own energy holding Vanguard Energy (VDE) was up 8.66%, which with a boost from our shorts helped us to achieve a fair relative performance. However, a big hit to Franklin FTSE Brazil (FLBR), down 11.47%, and a surprising drop of 6.95% in Vanguard Utilities (VPU) kept us on the ropes with the market, though not quite as bad as Vanguard's global balanced portfolio fund.

The drop in stocks last month was a little more oriented towards large caps, possibly because in recent weeks we saw the first real outflows from stock funds since early this year, and ETFs and other funds tend to be capitalization-weighted.

With a slightly rising U.S. dollar and weakness in many emerging markets, there was no help from foreign markets, except for Japan. The Chinese government's continued crackdown on tech companies has been dragging on Chinese stocks and the negativity may be spreading to other markets. The added worry is what appears to be a collapse of one of China's largest real estate companies, Evergrande. Our own China fund Franklin FTSE China (FLCH) was down only about as much as the S&P 500 last month, but much of the damage has been done as China has been the worst performing major market of 2021.

Everybody seems to know that all assets are expensive now, but the cost of not being in the risk party is slow erosion of purchasing power, as 2021 is shaping up to be a negative 3%+ return on near 0% yield cash, after adjusting for our new high inflation. Worse still for safety seekers, it seems as if speculators borrow your safe money at low rates and gamble in the riskier markets, from stocks to real estate - even cryptocurrencies.

Investors seem to have one eye on when the music will stop - and that could come in the form of higher interest rates or a slowing economy. The wages of fear for an investor today is a gamble of how much inflation the Fed will allow before ruining the speculative party. Ideally, inflation drifts back down and the Fed can slowly get back to normal while the economy ceases to need the twin stimuli of deficit spending and money creation. But the continuing stories of supply shortages and disruptions make so soft a landing look increasingly unlikely.

There have been large monthly inflows into stock funds for the first time in years. This investor confidence started in February of 2021 and held up until mid-September. This return to stocks may have reflected confidence early this year that the vaccines would get the global economy back on track. Unfortunately, once things look safe for investors, prices tend to be too high.

For years now, money has been coming out of stock funds, though most of this was just rebalancing into bonds as stocks did well. The last solid stretch of stock inflows, such as we are seeing now, was in 2017. The only down year for U.S. stocks since the 2007-09 crash was 2018, and 2018 was an even worse year for foreign markets, which is where most of the new money was going back then.

When investors start adding money to stock funds month after month, lousy returns often follow. We could be seeing the end of the run-up in stocks now.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)11.76%
Vanguard Energy (VDE)8.66%
ProShares Decline of Retail (EMTY)6.64%
Invesco CurrencyShares Euro (FXE)-2.01%
Vanguard Small-Cap Value (VBR)-2.55%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.37%
Vanguard FTSE Developed Mkts. (VEA)-3.39%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.43%
Vanguard Value Index (VTV)-3.94%
VanEck Vectors Pharma. (PPH)-4.23%
[Benchmark] Vanguard 500 Index (VFINX)-4.65%
Franklin FTSE China (FLCH)-4.78%
Homestead Value Fund (HOVLX)-5.38%
Vanguard FTSE Europe (VGK)-5.40%
Franklin FTSE Germany (FLGR)-5.63%
Franklin FTSE South Korea (FLKR)-6.83%
Vanguard Utilities (VPU)-6.95%
Franklin FTSE Brazil (FLBR)-11.47%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)-0.06%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.91%
Vanguard Long-Term Bond Index ETF (BLV)-2.52%
iShares JP Morgan Em. Bond (LEMB)-3.02%
Vanguard Extended Duration Treasury (EDV)-3.84%