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October 2023 Performance Review

November 19, 2023

Rising rates impacted nearly all fund categories in October. A global balanced portfolio of stocks and bonds fell harder than the S&P 500, as foreign stocks and global bonds underperformed, with rising rates contributing to the strengthening of the US dollar. Although numbers showing continued progress on inflation in November have so far reversed the downturn experienced in October, speculation about when rates will decrease continues to influence market movements. The housing market, in particular, seems most reliant on the belief that the current higher rates will not persist.

Our Conservative portfolio declined 3.60%, and our Aggressive portfolio declined 3.25%. Benchmark Vanguard funds for October 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 2.11%; Vanguard Total Bond Index (VBMFX), down 1.57%; Vanguard Developed Mkts Index (VTMGX), down 3.56%; Vanguard Emerging Mkts Index (VEIEX), down 3.44%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 2.95%.

The average fund category return was negative 2.26% in October, and the average fund category is now up under 1% for 2023. The strong returns are largely in larger-cap US growth stocks this year, as the S&P 500 is still up a solid 10.69% for the year with dividends, even with the drop in October. The only strong areas are risky debt as recession fears slip away, and stocks in Japan. The cryptocurrency bubble just won't die and is the hottest area this year, though still well off the 2021 highs.

With the strength in early November, The S&P 500 index is only about 5% away from all-time highs hit at the end of 2021. The bond market is still down about 20% from the highs, with longer-term government bonds down around 40% — the biggest drop ever.

In our own portfolios, what little gains we had in short funds were more than wiped out by drops in all stock funds and our long-term bond funds. The rising dollar particularly hit Franklin FTSE Germany (FLGR) hard with a 6.1% drop, and took down iShares JP Morgan Em. Bond (LEMB) 4.18%, a riskier debt fund that has actually done well relative to safe debt in recent years. Rising rates drove Vangaurd L/T Treasury (VGLT) down 7.31% and a whopping 11.41% hit to Vanguard Extended Duration Treasury (EDV). Rising rates have

Stocks are joining real estate in being priced as if the economy isn't going to slow down, inflation is heading back to target levels of around 2% a year, and interest rates will probably head down to around 3%. This could happen, but if it doesn't, there will be problems. Bubbling problems in commercial real estate also can't spread to the broader real estate market, much less the economy. Any deviation from this expectation will likely lead to lower real estate prices and stocks, but possibly higher bond prices as rates go down. The worst case for bonds is inflation settling into 3-4% as a new normal, the economy remains solid, real estate and stocks are okay with it as the Fed doesn't want to risk a crash and is comfortable with 5%-ish rates, and long-term rates go up to over 6% hurting bond prices again.

At this point in bond versus stock valuations, bonds offer a compelling risk-reward almost as good as in 2000 when stocks were a bit more pricey and bonds yielded closer to 6%, not 5%. There has been money going into longer-term bond funds lately, so investors aren't panic selling bonds after the losses, which would be the case if bonds were a true bargain today.

The renewed speculative energy by crypto and stock investors is a tough part of the economy to cool down with higher rates. The Fed faced the same problem in the 1920s when they raised rates not to cool inflation — which was low — but to cool speculation. When investors get it in their heads that stocks and real estate can't go down over a few years — reinforced by recent history — it doesn't matter if rates are 3% or 8%. Until it matters all of a sudden, as was the case in 1929.

Stock Funds 1mo %
ProShares UltraShort QQQ (QID) 11.43%
ProShares Decline of Retail (EMTY) 7.39%
Proshares Short High Yld (SJB) 2.06%
Franklin FTSE Brazil (FLBR) -0.65%
LeatherBack L/S Alt. Yld. (LBAY) -1.75%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) -2.06%
Franklin FTSE Japan ETF (FLJP) -2.36%
Invesco CurrencyShares Euro (FXE) -2.37%
VanEck Vectors Pharma. (PPH) -2.49%
Homestead Value Fund (HOVLX) -2.61%
Proshares Short Bitcoin (BITI) -2.86%
Vanguard Value Index (VTV) -3.27%
Franklin FTSE China (FLCH) -3.53%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) -3.71%
Vanguard FTSE Developed Mkts. (VEA) -3.78%
Vanguard Communications ETF (VOX) -3.86%
Vangaurd All-World Small-Cap (VSS) -4.25%
Vanguard FTSE Europe (VGK) -4.49%
[Benchmark] Vanguard 500 Index (VFINX) -4.77%
Franklin FTSE South Korea (FLKR) -5.12%
Franklin FTSE Germany (FLGR) -6.10%
UltraShort Bloom. Crude Oil (SCO) -9.81%
Bond Funds 1mo %
BondBloxx Six Month Treasury ETF (XHLF) 0.38%
[Benchmark] Vanguard Total Bond Index (VBMFX) -2.49%
iShares JP Morgan Em. Bond (LEMB) -4.18%
Vanguard Long-Term Bond Index ETF (BLV) -6.31%
Vangaurd L/T Treasury (VGLT) -7.31%
Vanguard Extended Duration Treasury (EDV) -11.41%

September 2023 Performance Review

October 10, 2023

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

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

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

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

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

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

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

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

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

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

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

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

Stock Funds 1mo %
ProShares UltraShort QQQ (QID) 11.43%
ProShares Decline of Retail (EMTY) 7.39%
Proshares Short High Yld (SJB) 2.06%
Franklin FTSE Brazil (FLBR) -0.65%
LeatherBack L/S Alt. Yld. (LBAY) -1.75%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) -2.06%
Franklin FTSE Japan ETF (FLJP) -2.36%
Invesco CurrencyShares Euro (FXE) -2.37%
VanEck Vectors Pharma. (PPH) -2.49%
Homestead Value Fund (HOVLX) -2.61%
Proshares Short Bitcoin (BITI) -2.86%
Vanguard Value Index (VTV) -3.27%
Franklin FTSE China (FLCH) -3.53%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) -3.71%
Vanguard FTSE Developed Mkts. (VEA) -3.78%
Vanguard Communications ETF (VOX) -3.86%
Vangaurd All-World Small-Cap (VSS) -4.25%
Vanguard FTSE Europe (VGK) -4.49%
[Benchmark] Vanguard 500 Index (VFINX) -4.77%
Franklin FTSE South Korea (FLKR) -5.12%
Franklin FTSE Germany (FLGR) -6.10%
UltraShort Bloom. Crude Oil (SCO) -9.81%
Bond Funds 1mo %
BondBloxx Six Month Treasury ETF (XHLF) 0.38%
[Benchmark] Vanguard Total Bond Index (VBMFX) -2.49%
iShares JP Morgan Em. Bond (LEMB) -4.18%
Vanguard Long-Term Bond Index ETF (BLV) -6.31%
Vangaurd L/T Treasury (VGLT) -7.31%
Vanguard Extended Duration Treasury (EDV) -11.41%

August 2023 Performance Review

September 13, 2023

With interest rates on the rise once again, stocks and bonds globally were down. The economy is not slipping into a recession so far, at least not in the USA. However, rates are expected to remain high due to escalating costs in energy and housing. Notably, only short-term bond funds exhibited growth last month, with almost all fund categories sinking. Some riskier bond funds were the exception, benefiting from a robust economy that supports higher default risk bonds.

Our Conservative portfolio declined by 2.66%, while our Aggressive portfolio saw a decrease of 3.14%. Benchmark Vanguard funds for August 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 1.59%; Vanguard Total Bond Index (VBMFX), down 0.58%; Vanguard Developed Mkts Index (VTMGX), down 4.05%; Vanguard Emerging Mkts Index (VEIEX), down 5.69%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, experienced a 2.57% decline.

It appears we have navigated through the majority of the inflation spurred by excessive money creation during Covid, combined with demand and supply issues after months of lockdown. The lingering effects are primarily due to a burgeoning real estate bubble and the government’s inability to curb the budget deficit — even during prosperous times. This has resulted in a continuous stimulus program while the Federal Reserve attempts to dampen inflation and slow the economy.

Increasing rates are making it expensive for the government to manage its substantial debt. The options to navigate this predicament seem limited to tolerating above 2% inflation targets or raising taxes. Although our debt-to-GDP ratio has been steadily climbing since the early 2000s, low interest rates mitigated the impact on debt payments relative to GDP. Unfortunately, this era is nearing its end; with the mounting interest rates, the financial burden on government revenues is set to become increasingly difficult to bear.

Historically, we have countered recessions with significant deficit spending, as seen in the responses to the 2000 recession (peak 3.3% deficit to GDP) and the Great Recession (peaking just under 10%). The COVID-19 pandemic escalated this to an almost 15% deficit-to-GDP budget. Alarmingly, we observe a persistent trend of growing deficits, now exacerbated by the spiraling interest charges on national debt and inflation-indexed government spending. Under current tax regulations and automatic spending plans, we are drifting towards a deficit exceeding 11%, a gap that appears insurmountable, even without the onset of a new crisis.

Surprisingly, the irrational housing market remains unfazed by the mortgage rate surpassing 7% and home prices eclipsing their 2006 peak when adjusted for inflation. Theoretically, home values should plummet to equalize monthly payments with the higher mortgage rate, but a stalemate between reluctant sellers and priced-out buyers has led to an unstable yet high market plateau.

Earlier this year, the banking sector faced a mini-crisis, a situation that might recur if rates continue to ascend. Remarkably, banks that rectified their mistakes following the mid-2000 housing bubble are now finding their focus on prime fixed-rate loans to be problematic. Some banks that faltered this year might have weathered the storm with a more diversified portfolio that included adjustable-rate subprime mortgages. Consequently, banks wouldn't be constrained to a fixed yield of 3% on their investments while having to pay some depositors rates approaching 5%.

Current investor apprehensions are primarily directed towards foreign markets, mainly China, standing on the precipice of a obubble collapse. Our Franklin FTSE China (FLCH) bore the brunt of this, depreciating by 9.46% last month, while most emerging markets collectively fell over 5%. Most of the debt in China is in the private sector and local governments. The relatively low debt government can theoretically bail out the economy by essentially taking on the debt, probably with increased state control. Although the Chinese government retains substantial borrowing capacity, contrasting with many major economies, it’s ambiguous how the US government plans to mitigate the impending economic crisis, with our borrowing capacity nearing its limit.

Long-term interest rates zoomed back up to the highs of 2022, sending some of our bond funds down for the year. The Vanguard Extended Duration Treasury (EDV), the most sensitive to rate alterations, fell by 4.67% last month. The resurgence in the US dollar’s value led to a 3.25% dip for iShares JP Morgan Em. Bond (LEMB) last month, even in a month where higher credit risk bond funds experienced a slight uptick.

The temptation is to run from bonds and foreign markets and chase hotter US growth markets, fueled by AI optimism. This will likely lead to more risk and lower returns in the coming years.

Stock Funds 1mo %
Franklin FTSE China (FLCH) 11.18%
Franklin FTSE South Korea (FLKR) 6.77%
Vanguard Communications ETF (VOX) 6.21%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) 5.91%
Vangaurd All-World Small-Cap (VSS) 4.93%
Proshares Short Bitcoin (BITI) 4.80%
Franklin FTSE Brazil (FLBR) 4.76%
Homestead Value Fund (HOVLX) 3.93%
Vanguard Value Index (VTV) 3.45%
[Benchmark] Vanguard 500 Index (VFINX) 3.21%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) 3.17%
Vanguard FTSE Developed Mkts. (VEA) 3.14%
Vanguard FTSE Europe (VGK) 2.90%
Franklin FTSE Japan ETF (FLJP) 2.66%
VanEck Vectors Pharma. (PPH) 2.61%
Franklin FTSE Germany (FLGR) 2.52%
LeatherBack L/S Alt. Yld. (LBAY) 2.18%
NightShares 2000 (NIWM) 2.02%
Invesco CurrencyShares Euro (FXE) 0.92%
Proshares Short High Yld (SJB) -0.76%
ProShares Decline of Retail (EMTY) -2.25%
ProShares UltraShort QQQ (QID) -7.03%
UltraShort Bloom. Crude Oil (SCO) -24.01%
Bond Funds 1mo %
iShares JP Morgan Em. Bond (LEMB) 1.49%
[Benchmark] Vanguard Total Bond Index (VBMFX) -0.06%
Vanguard Long-Term Bond Index ETF (BLV) -1.14%
Vangaurd L/T Treasury (VGLT) -2.22%
Vanguard Extended Duration Treasury (EDV) -3.93%

Trade Alert

August 25, 2023

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

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

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

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

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

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

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

Specifics about the liquidated fund:

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

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

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

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

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

July 2023 Performance Review

August 5, 2023

The stock market continued the fairly steady gains that started last fall and is now just around 5% below the all-time high of late 2021. This latest move up is in spite of interest rates drifting higher, leaving the bond market down far more than stocks since rates rose – dropping about 15% recently. The stock market is like a fighter in a movie, taking severe punishment in the form of rising rates and saying, "Is that all ya got?" to commentators asking "what is keeping him standing?" before a big comeback.

Our Conservative portfolio gained 1.23%, and our Aggressive portfolio gained 2.09%. Benchmark Vanguard funds for July 2023 were as follows: Vanguard 500 Index Fund (VFINX), up 3.21%; Vanguard Total Bond Index (VBMFX), down 0.06%; Vanguard Developed Mkts Index (VTMGX), up 3.17%; Vanguard Emerging Mkts Index (VEIEX), up 5.91%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, gained 2.64%.

Developing and smaller foreign markets picked up, and we saw a big 11.18% jump in Franklin FTSE China (FLCH) with a 6.77% move in Franklin FTSE South Korea (FLKR). For the US market, large-cap tech has been the primary driver this year, taking Vanguard Communication ETF (VOX) up 6.21%. Almost all of our drag last month was longer-term bonds, with a 3.93% hit to Vanguard Extended Duration Treasury (EDV) and a 2.22% drop in Vangaurd L/T Treasury (VGLT) as markets are growing fearful of US government debt and don’t think inflation is going to ease anytime soon. Essentially every fund category was up last month except for government bonds.

Risky bonds did well, notably our iShares JP Morgan Em. Bond (LEMB) stake, up 1.49% as investors' fear of debt defaults dropped to near historic lows. Energy and financial stock funds were the top two performers last month, reversing year-to-date losses in both fund categories.

The spinach to this Popeye stock market is the growing feeling that the economy can handle the significantly higher rates without a recession — unlike basically every other time the Fed raised rates. The so-called soft landing is now the expected outcome. Add in an Artificial Intelligence boom lifting many larger tech stocks, and we're off to the races.

Inflation is coming down, and the economy is strong, but the biggest drivers of higher prices are heading up again – housing, labor, and energy. The boom in prices is partially the result of low supply. The production of almost everything is lower than a few years ago – oil, homes, cars. There are many reasons for this; productivity has been so-so for a few years now, OPEC has cut production to keep prices high, and businesses from airlines to autos don’t want to flood the market and drive prices down.

Nowhere is the supply shortage distortion more of an issue than homes. Sellers don’t want to sell and lose their 3% mortgage. Buyers need lower prices or lower rates. We’re in a low-volume bubble. By most measures of real estate value for the country (like price to income or price to rent), we’re in a real estate bubble as overpriced as 2006 – and that ended poorly. The only real difference is buyers aren’t quite as leveraged because the no-money-down era is mostly gone.

It would be very difficult to get inflation down to the target of 2% without some sort of break in home prices. The high prices and general unaffordability of a new home purchase are lifting rents as more potential buyers can’t afford to buy.

But the market isn’t worried about the collapse of a second real estate bubble. More recently, the market – at least the bond market – is starting to worry about the US Government's increasingly precarious financial situation.

Fitch, one of the three big bond ratings companies, lowered the US government's debt rating from AAA to AA+, similar to what S&P did in 2011. Only Moody's still holds the US government as highly as say, Norway or Germany. While the actual risk of default is realistically zero, the issues raised are real. The only thing going well for the government's balance sheet right now is inflation reducing the amount of debt we have relative to our inflating GDP – we’re inflating ourselves out of debt, similar to the post-WW2 experience. This is why bondholders are suffering.

Since the government isn’t capable of cutting spending and raising taxes to right the ship – the Fed has to raise rates to lower inflation, which only makes the problem worse as the economy could drag, reducing tax revenues, while the cost of our existing debt mushrooms. Fitch expects our annual deficit to be over 6% of GDP in 2023 from 3.7% in 2022, which is crazy for a strong economy.

For now, the stock market doesn’t care how the government is going to fix this later, and if they keep using above-target inflation, well, stocks and real estate may do better than bonds once again. Meanwhile, longer term interest rates are approaching 100-year average yields and a big improvement from the near-zero rates globally for much of the post-2000 era when the Fed used low rates to fix things.

Stock Funds 1mo %
Franklin FTSE China (FLCH) 11.18%
Franklin FTSE South Korea (FLKR) 6.77%
Vanguard Communications ETF (VOX) 6.21%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) 5.91%
Vangaurd All-World Small-Cap (VSS) 4.93%
Proshares Short Bitcoin (BITI) 4.80%
Franklin FTSE Brazil (FLBR) 4.76%
Homestead Value Fund (HOVLX) 3.93%
Vanguard Value Index (VTV) 3.45%
[Benchmark] Vanguard 500 Index (VFINX) 3.21%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) 3.17%
Vanguard FTSE Developed Mkts. (VEA) 3.14%
Vanguard FTSE Europe (VGK) 2.90%
Franklin FTSE Japan ETF (FLJP) 2.66%
VanEck Vectors Pharma. (PPH) 2.61%
Franklin FTSE Germany (FLGR) 2.52%
LeatherBack L/S Alt. Yld. (LBAY) 2.18%
NightShares 2000 (NIWM) 2.02%
Invesco CurrencyShares Euro (FXE) 0.92%
Proshares Short High Yld (SJB) -0.76%
ProShares Decline of Retail (EMTY) -2.25%
ProShares UltraShort QQQ (QID) -7.03%
UltraShort Bloom. Crude Oil (SCO) -24.01%
Bond Funds 1mo %
iShares JP Morgan Em. Bond (LEMB) 1.49%
[Benchmark] Vanguard Total Bond Index (VBMFX) -0.06%
Vanguard Long-Term Bond Index ETF (BLV) -1.14%
Vangaurd L/T Treasury (VGLT) -2.22%
Vanguard Extended Duration Treasury (EDV) -3.93%

June 2023 Performance Review

July 5, 2023

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

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

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

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

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

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

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

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

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

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

Stock Funds 1mo %
Franklin FTSE Brazil (FLBR) 15.01%
[Benchmark] Vanguard 500 Index (VFINX) 6.60%
Homestead Value Fund (HOVLX) 6.45%
Vanguard Value Index (VTV) 6.13%
Franklin FTSE Japan ETF (FLJP) 4.96%
LeatherBack L/S Alt. Yld. (LBAY) 4.81%
Vanguard Communications ETF (VOX) 4.75%
Vanguard FTSE Developed Mkts. (VEA) 4.46%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) 4.44%
Vanguard FTSE Europe (VGK) 4.33%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) 4.30%
Vangaurd All-World Small-Cap (VSS) 4.13%
VanEck Vectors Pharma. (PPH) 4.12%
Franklin FTSE China (FLCH) 3.95%
Invesco CurrencyShares Euro (FXE) 2.26%
Franklin FTSE Germany (FLGR) 1.76%
Franklin FTSE South Korea (FLKR) 0.59%
NightShares 2000 (NIWM) 0.04%
Proshares Short High Yld (SJB) -1.24%
ProShares Decline of Retail (EMTY) -8.30%
UltraShort Bloom. Crude Oil (SCO) -11.16%
ProShares UltraShort QQQ (QID) -11.30%
Proshares Short Bitcoin (BITI) -12.55%
Bond Funds 1mo %
iShares JP Morgan Em. Bond (LEMB) 1.59%
Vanguard Long-Term Bond Index ETF (BLV) 1.04%
Vanguard Extended Duration Treasury (EDV) 1.01%
Vangaurd L/T Treasury (VGLT) 0.02%
[Benchmark] Vanguard Total Bond Index (VBMFX) -0.38%

May 2023 Performance Review

June 5, 2023

The economy remains surprisingly buoyant, despite the Federal Reserve's relentless rate increases to temper persistent, high inflation. Given that we're still in a real estate bubble, built upon a foundation of low rates and lax Covid-related fiscal and monetary policy, this is quite a remarkable feat. Surprisingly, big tech and growth names, which suffered significantly in 2022, have bounced back. This resurgence is notable because these entities were hit hard, in part due to rising rates that diminished the value of future earnings growth. Interest rates continue to be high, and long-term rates—though significantly lower than their 2022 peak—are climbing again. This trend is leading to a decline in most bond funds and causing mortgage rates to rise. Despite investors capitalizing on the risk-free 5% yield, it seemingly hasn't had a negative impact on the market.

Our Conservative portfolio declined by 2.87%, and our Aggressive portfolio dropped by 1.63%. Benchmark Vanguard funds for May 2023 were as follows: Vanguard 500 Index Fund (VFINX), up 0.43%; Vanguard Total Bond Index (VBMFX), down 1.09%; Vanguard Developed Mkts Index (VTMGX), down 3.70%; Vanguard Emerging Mkts Index (VEIEX), down 2.48%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.73%.

With bonds and value stocks down, we had a challenging month relative to the large cap growth-heavy S&P 500, which was up by less than 1%. Factor in a strong US dollar dragging on the values of foreign stocks and bonds, and we experienced almost all drag in May. We were not alone. The S&P 500 landed in the top 7% or so of all fund categories even with just a 0.43% showing, as over 90% of fund categories were down last month. The S&P 500 was also in the top 5% of all fund categories for the year with a 9.65% return. This masks the wild outperformance of growth relative to value stocks. Tech funds were up around 8% last month and 22% for the year, with large-cap growth close behind, up over 16% for the year and approximately 3.5% last month.

Meanwhile, value stocks, which performed well in 2022 as the growth market crashed, are severely lagging in 2023. This is evident in our Vanguard Value Index (VTV) holding, down 4.12% last month and now down 3.41% for the year. On the flipside, our recently re-added Vanguard Communication ETF (VOX), which has large cap tech stock exposure, was up 2.61% last month and a staggering 23.79% this year. This performance spread between value and growth stocks is hurting LeatherBack L/S Alt. Yld. (LBAY), now down 13.2% for the year after a drop of 7.33% last month. Many market-neutral and long-short funds essentially short expensive stocks and buy value, a recipe for disaster when the tech bubble re-inflates.

Our communications fund was on our short list of winners this year, with our oil short up 21%, Franklin FTSE Germany (FLGR) up 13.57% for the year even after dropping 4.76% last month, and a 13.45% gain for the year in our retail stock short as we're seeing retailers collapse as the Covid stimulus money runs out, notably Bed Bath & Beyond. This will only add to the trauma brewing in commercial real estate as work-from-home continues at levels that can hurt offices financed by once-low rates.

One might assume that rising rates would induce a recession, quash the speculative frenzy in growth stocks, and pop our second real estate bubble. Somewhere after the dust settles and we return to 0% rates, a new speculative boom would likely rise from the ashes.

Investors appear to have collectively decided to anticipate the next crash because we don't know when it will happen or where the bottom will be, but we are confident that in 5 years we'll reach new highs on a fresh boom. The new speculative boom seems to be AI, and to a lesser extent, virtual reality. The first wave of AI – such as Siri and other smart devices – was a disappointment, as was the early excitement around virtual reality, the metaverse, Google Glass, etc.

We've seen many speculations about the future that haven't lived up to stock prices along the way, and we'll have to see if this latest boom will be one of the significant ones, like PCs, the Internet, or the Smartphone, or an expensive dud like nanotechnology, crypto, or self-driving cars (so far).

This boom had better live up to the hype – investors are forgoing a risk-free 5% yield to own a piece of the AI future. Ironically, if the hype is real, this tech advancement, if it doesn’t wipe us out, may just destroy enough of the economy as jobs get replaced by software, potentially negating any benefits from productivity, at least in the short run.

Stock Funds1mo %
UltraShort Bloom. Crude Oil (SCO)19.45%
ProShares Decline of Retail (EMTY)15.47%
Proshares Short Bitcoin (BITI)7.77%
Franklin FTSE South Korea (FLKR)3.83%
Vanguard Communications ETF (VOX)2.61%
Franklin FTSE Brazil (FLBR)2.25%
Proshares Short High Yld (SJB)1.74%
NightShares 2000 (NIWM)0.87%
Franklin FTSE Japan ETF (FLJP)0.52%
[Benchmark] Vanguard 500 Index (VFINX)0.43%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.48%
Invesco CurrencyShares Euro (FXE)-2.93%
Vangaurd All-World Small-Cap (VSS)-3.50%
Homestead Value Fund (HOVLX)-3.54%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.70%
Vanguard FTSE Developed Mkts. (VEA)-3.73%
VanEck Vectors Pharma. (PPH)-4.08%
Vanguard Value Index (VTV)-4.12%
Franklin FTSE Germany (FLGR)-4.76%
Vanguard FTSE Europe (VGK)-5.12%
LeatherBack L/S Alt. Yld. (LBAY)-7.33%
Franklin FTSE China (FLCH)-9.04%
ProShares UltraShort QQQ (QID)-13.75%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)0.72%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.09%
Vangaurd L/T Treasury (VGLT)-2.79%
Vanguard Long-Term Bond Index ETF (BLV)-2.91%
Vanguard Extended Duration Treasury (EDV)-4.23%

April 2023 Performance Review

May 5, 2023

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

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

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

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

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

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

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

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

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

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

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

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

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

Stock Funds1mo %
Vanguard FTSE Europe (VGK)4.13%
Franklin FTSE Germany (FLGR)3.69%
Franklin FTSE Brazil (FLBR)3.42%
Vanguard FTSE Developed Mkts. (VEA)2.63%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.55%
VanEck Vectors Pharma. (PPH)2.45%
Vanguard Communications ETF (VOX)2.32%
Homestead Value Fund (HOVLX)2.01%
Vanguard Value Index (VTV)1.77%
Invesco CurrencyShares Euro (FXE)1.72%
Vangaurd All-World Small-Cap (VSS)1.57%
[Benchmark] Vanguard 500 Index (VFINX)1.56%
LeatherBack L/S Alt. Yld. (LBAY)0.57%
Franklin FTSE Japan ETF (FLJP)0.52%
ProShares Decline of Retail (EMTY)0.34%
Proshares Short High Yld (SJB)0.22%
Franklin FTSE South Korea (FLKR)-0.54%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-0.66%
ProShares UltraShort QQQ (QID)-0.68%
NightShares 2000 (NIWM)-0.94%
Proshares Short Bitcoin (BITI)-3.18%
UltraShort Bloom. Crude Oil (SCO)-3.97%
Franklin FTSE China (FLCH)-4.27%
Bond Funds1mo %
Vanguard Long-Term Bond Index ETF (BLV)0.66%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.54%
Vangaurd L/T Treasury (VGLT)0.51%
iShares JP Morgan Em. Bond (LEMB)0.36%
Vanguard Extended Duration Treasury (EDV)0.14%

March 2023 Performance Review

April 6, 2023

Despite the recent stress in the regional banking industry, both the stock and bond markets performed well last month. As a result of the situation, hundreds of billions of dollars left banks and flowed into money market funds that invest in Treasury bills, which now offer close to a 5% yield. Furthermore, the ten-year government bond rate has dropped to around 3.3% from its peak of almost 4% in late February, and is now a full percentage point lower than it was last October. This drop in rates could potentially benefit banks, as the main problem they have faced so far is losses on their loans due to rising interest rates. Additionally, the lower rates may lead to increased activity in the real estate market.

In March 2023, our Conservative portfolio gained 2.52%, while our Aggressive portfolio gained 2.13%. Our benchmark Vanguard funds for the same period were Vanguard 500 Index Fund (VFINX) up 3.67%, Vanguard Total Bond Index (VBMFX) up 2.56%, Vanguard Developed Mkts Index (VTMGX) up 2.63%, Vanguard Emerging Mkts Index (VEIEX) up 2.54%, and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.79%.

Last month, the stocks that experienced the biggest gains were often those that had the most significant declines in 2022. Precious metals funds saw an increase of over 10% as investors speculated that the Federal Reserve would need to lower interest rates and take a more relaxed approach to combating inflation due to the recent bank panic. Additionally, many investors sought out supposedly safe assets during the crisis. However, it should be noted that gold has a questionable track record when it comes to protecting against financial crises.

In March, the main action in the stock market was in large-cap growth and technology stocks, which saw gains of 5 to 6% in most funds in these areas. Our recently re-added Vanguard Communication ETF (VOX) fund was our top performer, with a return of 6.87%. Additionally, our single country funds performed well and outperformed the S&P 500 as the US dollar weakened.

There's a growing myth that the US dollar is losing its reserve status. Firstly, given our large investments abroad, a drop in the dollar wouldn't be all that bad. Secondly, it's highly unlikely to happen in my lifetime. Other countries simply don't have what it takes — it requires a combination of a large economy, stable inflation (or at least more stable than others), the ability to create money at will (as we've just done to address issues in the banking system), and attractive property rights, taxes, and non-restrictive capital controls (sorry, China). So, don't hold your breath.

We were able to keep pace with the globally balanced Vanguard STAR fund, thanks to strong returns on our bond investments. As interest rates decreased, we saw a near 6% increase in Vanguard Extended Duration Treasury (EDV) and a close second with Vangaurd L/T Treasury (VGLT). Additionally, foreign bonds did well, with iShares JP Morgan Em. Bond (LEMB) seeing a 3.18% increase, outperforming the bond index. Our underperforming funds were mostly shorting, notably our inverse Bitcoin bet Proshares Short Bitcoin (BITI), which fell nearly 25% as crypto enthusiasts believe the banking crisis will only increase the likelihood of digital currencies taking over banking. Banks receive a Fed loan when they have trouble and all depositors receive a bailout. The fact that Roku received their $500 million back from Silicon Valley Bank while Mr. Roku watcher lost his $50,000 investment at FTX highlights why banks are safer than crypto – not the other way around.

Regarding the current state of the markets, the primary area of concern is the collapse of banks. Let's examine the situation.

The recent banking crisis was not caused by an economic downturn or loan defaults, as is typical in banking problems. Rather, it was the result of regional banks, which are subject to less stringent regulations put in place after the Great Recession, taking in a large amount of deposits, particularly in response to the trillions of dollars distributed by the government in response to the Covid pandemic. These banks paid very low interest rates on these deposits, while making loans at 3-6% and investing in US government bonds that yielded only 1-2%. Thanks to rapid rate increases to fight inflation, the value of these government bonds fell by 10-20%, as did the banks' loans (which are not marked to market), the banks found themselves sitting on trillions of dollars in paper losses, including nearly a trillion in government bonds.

This alone would not have been a major problem, except that when short-term interest rates rose to nearly 5%, the banks attempted to maintain their profits by continuing to pay almost nothing on deposits. Some banks that dealt primarily with uninsured depositors, who held more than $250,000 in the bank, took advantage of looser rules and invested aggressively, without maintaining sufficient cash to handle potential liquidations or making questionable loans. Some even opened their banks to "hot money" from the cryptocurrency industry. When some of their largest balance clients, with $50 million to $500 million in deposits, realized that the banks were making risky loans to themselves and their tech companies, and needed to raise capital, they began an old-fashioned bank run, only at internet speed.

This has resulted in over $20 billion in losses for the Federal Deposit Insurance Corporation (FDIC), as well as hundreds of billions of dollars in Federal Reserve loans to enable other regional banks to handle withdrawals. The best case scenario is that lending will be reduced for years and bank profits will suffer, not just from the shrinking spread between the rates banks lend and borrow at, but also due to the fact that the "good" banks will be paying for the FDIC bailouts for years with higher insurance fees. Additionally, there will likely be increased regulations on mid-size banks.

In some ways, this is exactly what the Federal Reserve wants: to remove excess money from the banking system and slow down the economy. Stocks have done well during this crisis because investors anticipate that the worst is behind us and that the Fed will need to lower interest rates to stimulate the economy in the coming months. However, this is an overly optimistic view. There is an equally likely scenario where investors can earn safe, relatively high bond yields now and then switch to stocks when the economy falters and interest rates fall. The "buy now" strategy assumes that such a sale will never happen, but this is risky because the market can be volatile, as was seen during the Covid pandemic when stocks initially fell by nearly 40%, only to be almost completely restored in just a few months of zero interest rate policy.

It might be wise to wait for a true panic before making the switch from bonds to stocks.

Stock Funds1mo %
Vanguard Communications ETF (VOX)6.87%
Franklin FTSE Japan ETF (FLJP)4.77%
Franklin FTSE Germany (FLGR)4.10%
Franklin FTSE China (FLCH)3.91%
Franklin FTSE South Korea (FLKR)3.80%
[Benchmark] Vanguard 500 Index (VFINX)3.67%
Invesco CurrencyShares Euro (FXE)2.68%
Vanguard FTSE Developed Mkts. (VEA)2.63%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.63%
VanEck Vectors Pharma. (PPH)2.62%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)2.54%
Vanguard FTSE Europe (VGK)2.46%
ProShares Decline of Retail (EMTY)1.19%
Vangaurd All-World Small-Cap (VSS)0.87%
Franklin FTSE Brazil (FLBR)0.56%
NightShares 2000 (NIWM)0.24%
UltraShort Bloom. Crude Oil (SCO)0.00%
Vanguard Value Index (VTV)-0.47%
Homestead Value Fund (HOVLX)-0.95%
LeatherBack L/S Alt. Yld. (LBAY)-1.57%
Proshares Short High Yld (SJB)-1.76%
ProShares UltraShort QQQ (QID)-16.68%
Proshares Short Bitcoin (BITI)-24.39%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)5.96%
Vangaurd L/T Treasury (VGLT)4.67%
Vanguard Long-Term Bond Index ETF (BLV)4.62%
iShares JP Morgan Em. Bond (LEMB)3.18%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.56%

February 2023 Performance Review

March 4, 2023

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

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

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

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

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

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

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

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

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

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

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

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

Stock Funds1mo %
UltraShort Bloom. Crude Oil (SCO)5.17%
ProShares Decline of Retail (EMTY)4.07%
Proshares Short High Yld (SJB)2.23%
ProShares UltraShort QQQ (QID)0.14%
Proshares Short Bitcoin (BITI)-1.14%
Vanguard FTSE Europe (VGK)-1.71%
[Benchmark] Vanguard 500 Index (VFINX)-2.44%
Invesco CurrencyShares Euro (FXE)-2.64%
Franklin FTSE Germany (FLGR)-2.84%
Homestead Value Fund (HOVLX)-2.86%
Vangaurd All-World Small-Cap (VSS)-3.15%
Vanguard Value Index (VTV)-3.24%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.40%
VanEck Vectors Pharma. (PPH)-3.43%
Vanguard FTSE Developed Mkts. (VEA)-3.47%
Vanguard Communications ETF (VOX)-4.07%
Franklin FTSE Japan ETF (FLJP)-4.36%
LeatherBack L/S Alt. Yld. (LBAY)-5.73%
NightShares 2000 (NIWM)-5.88%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-6.27%
Franklin FTSE South Korea (FLKR)-7.41%
Franklin FTSE Brazil (FLBR)-10.39%
Franklin FTSE China (FLCH)-10.72%
Bond Funds1mo %
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.55%
iShares JP Morgan Em. Bond (LEMB)-2.78%
Vangaurd L/T Treasury (VGLT)-4.73%
Vanguard Long-Term Bond Index ETF (BLV)-5.13%
Vanguard Extended Duration Treasury (EDV)-6.37%

January 2023 Performance Review

February 7, 2023

Stocks and bonds rebounded sharply in January as investors upped bets on a so-called soft landing in the economy. Expectations of falling inflation without a serious recession led to a flurry of dip buying, notably in the hardest-hit areas of last year. Falling longer-term interest rates pushed up bond prices but imply low inflation and probably a recession are in the cards. Economic numbers are by and large very good, considering how fast interest rates have risen, but then it takes time for rate increases to help start a recession, historically.

Our Conservative portfolio gained 5.80%, and our Aggressive portfolio gained 5.58%. Benchmark Vanguard funds for January 2023 were as follows: Vanguard 500 Index Fund (VFINX), up 6.28%; Vanguard Total Bond Index (VBMFX), up 3.19%; Vanguard Developed Mkts Index (VTMGX), up 8.65%; Vanguard Emerging Mkts Index (VEIEX), up 7.77%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 7.20%.

With the dramatic rebound in January, our portfolios clawed back a good chunk of last year’s losses all in one month. This third rebound attempt since the stock and bond market turned way down just over a year ago might already be petering out. The economy is looking a little too hot, which could keep the Federal Reserve in inflation red-alert mode. With the latest rate hike, we’re just under 5% on safe risk-free cash, which somehow hasn’t crashed the economy, housing, or stock market so far. The expectation is these rates won’t last, so why load up the truck on cash?

One reason for the excitement is that longer-term rates have been heading down since October, which is why bond funds are doing well again after 2022 proved to be the worst calendar year for investment-grade debt pretty much ever. In theory, if the economy wasn’t going to slow down much and this was a great time to buy stocks after last year’s dip, interest rates would be flat or moving up. Bonds are saying recession; stocks are saying no recession. It is possible there is some sort of Goldilocks economy market scenario where longer- term rates are 2–3%, inflation down to 2%, and the economy and stocks are strong.

At the top of our hits was recently added Vanguard Communication ETF (VOX), up 15.02% as investors piled into hard-hit tech and communications stocks, pushing this category to the top 3% of all fund categories last month. The US dollar is weakening after a strong year on expectations our rates are not going any higher. This, plus bargain shopping, led to many foreign funds rising more than the S&P 500; notably Franklin FTSE Germany (FLGR), Franklin FTSE China (FLCH), and Franklin FTSE South Korea (FLKR) up over 13% as a group.

Value stocks did very well compared to growth stock in 2022. While both were down, growth stocks were down around 33% while value stocks were down around 2%. This 31% performance gap is the largest on record since the unwinding of the dot com bubble in 2000. The years 2022 and 2000 are the biggest gaps since at least the late 1970s. As it turns out, during a stock boom, investors flock to growth stories and overpay.

So far in 2023 this trend is reversing, with growth leading the way by far. It is too soon to tell if the relative bottom is in in growth stocks. It is just as possible that both will fall more together as the growth fluff is gone, but the overall market is still pricy relative to now high interest rates.

Our value- and dividend-oriented holdings performed poorly last month, with VanEck Vectors Pharma. (PPH) up just 0.77% and our value funds Homestead Value Fund (HOVLX) and Vanguard Value Index (VTV) both up only about half as much as the S&P 500. The real drags were our shorts; notably, Proshares Short Bitcoin (BITI) down 30% as deluded gamblers—or visionaries, depending on your opinion of digital currencies—piled back into Bitcoin after a collapse in 2022. Digital “asset” funds (an oxymoron) were up around 40% last month but are still down 44% over the last 12 months and are negative over the past 5 years. The only real weak areas in January were utilities funds, down fractionally, and funds that invest in India, also down slightly.

We even had big gains in rate-sensitive bonds, with Vanguard Extended Duration Treasury (EDV) up 10.18%, Vanguard Long-Term Bond Index ETF (BLV) up 7.26%, and Vangaurd L/T Treasury (VGLT) up 7.14%. Both have a long way to go to regain old highs; in fact, they may never hit old highs unless rates plunge anew. That said, we’re also enjoying the higher yields now. The worst thing for bonds would be some sort of panic selling in the bond market if investors decide we can’t get inflation or deficit spending under control. We’re considering adding back inflation-adjusted bond funds, as pricing is now favorable compared to Series I bonds purchased directly from the Treasury.

Stock Funds1mo %
Vanguard Communications ETF (VOX)15.02%
Franklin FTSE Germany (FLGR)13.70%
Franklin FTSE China (FLCH)13.37%
Franklin FTSE South Korea (FLKR)12.94%
Vanguard FTSE Europe (VGK)9.56%
Vanguard FTSE Developed Mkts. (VEA)9.03%
Vangaurd All-World Small-Cap (VSS)8.76%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)8.65%
Franklin FTSE Brazil (FLBR)8.36%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)7.77%
Franklin FTSE Japan ETF (FLJP)7.32%
[Benchmark] Vanguard 500 Index (VFINX)6.28%
Vanguard Value Index (VTV)2.79%
Homestead Value Fund (HOVLX)2.68%
Invesco CurrencyShares Euro (FXE)1.58%
NightShares 2000 (NIWM)1.40%
VanEck Vectors Pharma. (PPH)0.77%
UltraShort Bloom. Crude Oil (SCO)0.55%
LeatherBack L/S Alt. Yld. (LBAY)0.37%
Proshares Short High Yld (SJB)-3.26%
ProShares Decline of Retail (EMTY)-7.02%
ProShares UltraShort QQQ (QID)-18.56%
Proshares Short Bitcoin (BITI)-30.18%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)10.18%
Vanguard Long-Term Bond Index ETF (BLV)7.26%
Vangaurd L/T Treasury (VGLT)7.14%
iShares JP Morgan Em. Bond (LEMB)3.54%
[Benchmark] Vanguard Total Bond Index (VBMFX)3.19%

December 2022 Performance Review

January 5, 2023

2022 was one of the worst calendar years for the stock market. The 18.15% drop in the S&P 500 (including dividends and index fund fees) was the seventh worst annual hit since the 1920s. This in itself is not that remarkable. The interesting part was that the bond market was also down 13.25% – essentially the worst year in history for the bond market.

For the month, our Conservative portfolio fell by 1.30%, while our Aggressive portfolio dropped by 1.21%. Benchmark Vanguard funds for December 2022 were as follows: Vanguard 500 Index Fund (VFINX) down 5.77%; Vanguard Total Bond Index (VBMFX) down 0.61%; Vanguard Developed Mkts Index (VTMGX) down 2.16%; Vanguard Emerging Mkts Index (VEIEX) down 2.10%; and Vanguard Star Fund (VGSTX), a complete global balanced portfolio, down 3.40%.

For the year, our Aggressive portfolio was down 11.36% or around 62% of the stock market’s downside, while our more bond-heavy Conservative portfolio slid a whopping 15.31%, representing almost 85% of the stock market decline. There was no help from abroad as Vanguard Developed Mkts Index (VTMGX) was down 15.32% and Vanguard Emerging Mkts Index (VEIEX) was down 17.90%.

Our favorite overall benchmark (because it is globally balanced at roughly 60% stocks 40% bonds, with low fees) is Vanguard Star Fund (VGSTX), and this moderate risk fund was down 17.99% in 2022. The only year previously that this fund had been down more than 10% since 1987 was in 2008, when it had a return of -25.1%. So, the only good thing we can say is that both our portfolios beat this fund by falling less, which is also what happened in 2008.

It is hard to find a balanced total portfolio fund that has fallen by less than 15% in 2022, highlighting what a tough year it has been for lower-risk investors. The best performing Vanguard total portfolio fund from 2022 was the low-risk and low-fee Vanguard Target Retirement Income fund (VTINX). This fund is for those in retirement looking for income and is comprised of 67% bonds, 3% cash and 30% stocks. It was down 12.74% in 2022. Factor in near 10% inflation and this was a bad year for those in retirement.

The Vanguard Balanced Index (VBINX) has been around since 1993. This year it was down 16.97%. The only other time this fund has been down by more than 10% was in 2008, when it fell by 22.21%. The key difference is that in 2008 the stock market was down just over 37% and it was the second-worst calendar year on record for stocks, after 1931. What makes this year unusually bad is not that stocks were down by around 18%, but that because of the poor performance of the bond market, balanced ‘safe’ portfolios were hit almost as hard as in 2008 when stocks were down almost 40% (and investment-grade bonds were up).

The Vanguard Total Bond Index (VBMFX) was launched in 1986. Until this year’s 13.25% drop, the worst year for that fund had been a -2.66% return in 1994. Vanguard Long-Term Investment-Grade Inv (VWESX) invests in longer-term, more rate-sensitive bonds. Launched in the 1970s, its previous worst year was 1999 when the Fed raised rates to sink the dotcom bubble, sending the fund down 6.23%. This year the fund was down 25.62% – and that is after a rebound late in the year as rates slipped on recession fears. In late October this fund was down 32.8%! Many bond funds now have near-zero 10-year total returns – also a first by a wide margin.

Fortunately, we have cut back somewhat on longer-term bond funds in recent years, but the lower-duration bond funds we had added were still down by double digits. We should have just kept the funds in cash and accepted the 0% returns (which are now over 4%), but the fear of earning nothing with near 10% inflation, and the ‘knowledge’ that these safer bond funds ‘never’ fall by more than 10% proved a disaster of sorts.

Speaking of disasters, the twin disasters for the bond market were the Fed raising rates much faster than in the past to stop the multi-decades-high inflation, partially if not largely, created by the loose monetary policy of low rates and new money creation, AND a low starting yield. In other words, if rates had been 4% and the Fed had raised them to 6% relatively quickly, the price hit would have been partially offset by the 3% and rising yields. However, the starting yield was 1.7% in January for 10-year government bonds so the move to 3.7% (and briefly over 4%) was all price pain and little yield gain.

Note that the broad ‘bond market’ in index funds is investment-grade (no junk bonds) debt and since most bonds have less than 10 years to maturity, the bond market index is low risk in terms of rising rates and default risk. The bond market has a duration of less than 7, meaning that with a 1% rise in rates you lose around 7% in price. The average credit rating is AA as half the bonds are government-backed.

Rising rates ultimately hit stocks (and eventually real estate) because a company that earns 5% a year (20 P/E ratio) and pays out a 2% dividend isn’t as valuable when you can buy a safe 5% bond with essentially no default risk. A rental property that yields 2%-3% after expenses isn’t a very compelling investment if you can get inflation plus 2% in a no-default-risk bond. Note that currently even with a price pull-back of about 25% in 2022, the Vanguard REIT Index fund (VGSLX) yields just 2.2%, not including capital gains from property sales and return of capital.

The scary part is no longer bonds (or at least investment grade bonds), but stocks (and real estate). The current dividend yield on stocks after a top-10 bad year is STILL just 1.7%. Considering that riskier stocks and recent IPOs and cryptocurrencies are down 40%-90%+ across the board, with the Nasdaq index down 33% in 2022, the fact that stocks are still this pricy is remarkable.

Meanwhile, no-risk T-bills pay 4.3%. Investors are basically betting that rates will go back down soon and stocks are reasonably priced for the near-future sub-2% rates. The same ‘logic’ is being applied in the property market, which hasn’t yet taken a big hit. Sellers and some buyers are assuming that sub-4% mortgages are just around the corner, so why mark down the price by 20% to adjust for high rates? In the few deals happening in an otherwise frozen market, buyers probably think, ‘No problem, we’ll just refinance in a few years at a lower rate’. It is possible, but such speculation is just the kind the Fed is trying to end in the economy to bring down inflation. More likely to support the property market than 3% mortgages being just around the corner, is inflation not dipping below 4% and rent increases supporting the currently high property prices. Another problem with the 'buy now, refi at 3% later' mentality is 3% mortgages will likely occur during the next mini financial crisis and your recently bought 7% mortgage property may be down 30% in price and ineligible for a refi without a 2009 grade Government program to allow underwater refis.

We’ve seen much harder hits to stocks over more than a calendar year. The 2000 bubble really broke down over three years, with the Nasdaq down over 20% each year for three years in a row, amounting to a total loss of almost 80%. Could it happen again? Probably not for the tech index as a whole, as many of these companies are now established and make money; it is unlikely a capitalization-weighted index of companies including Apple (AAPL) and Microsoft (MSFT) would fall by 80% again.

‘Junky’ growth and bubble stocks are already down by 80%. A more likely worst-case scenario is a 50% top-to-bottom Nasdaq slide and a 90%+ slide in formerly popular stocks of the future (with many worth zero). This relates to innovation stocks such as those in the still (remarkably) popular ARK Innovation ETF (ARKK), which was down 67% in 2022, after a 23% drop in 2021; a total drop from the 2021 peak to the end of 2022 of around 80%, just as happened with the Nasdaq in 2000–2003. In recent months even the mighty Tesla (TSLA) bubble has finally popped, sending its stock down 65% in 2022. We’ve been waiting for these bubbles to pop and are glad to see the froth leave the market. Unfortunately, investors’ enthusiasm for these busted boom stocks is still too high.

It is likely our focus on foreign stocks would have helped somewhat this year had it not been for the war in Ukraine and the ensuing troubles in European economies, which resulted in a fast-rising US dollar that has only recently cooled off. Even with the recent rebound, we took some bruising hits abroad, with a 28.06% drop in Franklin FTSE South Korea (FLKR) and 24.72% drop in Franklin FTSE Germany (FLGR). China was at one point down over 40%, but a year-end sharp rebound has left us with just a 22.78% drop in Franklin FTSE China (FLCH). The stock winners were short funds, led by a 66.3% gain in ProShares UltraShort QQQ (QID), a perennial loser except when tech stocks tank, which we’ve been waiting for since the Covid stock bubble. Value oriented stocks did fine, with Vanguard Value Index (VTV) down just 2.1% for the year. VanEck Vectors Pharma. (PPH) was up 2.61% and Franklin FTSE Brazil (FLBR) scored a 10.78% year, being a beneficiary of rising commodity prices. Homestead Value Fund (HOVLX) was down just 5.5% for the year. Value stocks are no longer such a good deal relative to growth stocks.

Our biggest hits were actually in bonds, with a near 40% drop in Vanguard Extended Duration Treasury (EDV) and a 26.93% hit to Vanguard Long-Term Bond Index ETF (BLV). More frustrating were our losses in recently exited mortgage bonds, which only fell slightly less in 2022 than the inflation-adjusted bond funds we dumped for being over-priced as inflation increased. Former holding, Vanguard Mortgage-Backed Secs ETF Vanguard Mortgage-Backed Securities (VMBS) was down 11.9% in 2022, only slightly better than the former holding (sold in early 2021) of Schwab US TIPS Schwab US TIPS (SCHP) which was down 12.02% in 2022. We should have just gone to 0% yield cash.

Surprisingly, riskier bonds didn’t perform much worse than investment-grade bonds – the whole crash was primarily a rate adjustment rather than a credit risk one; risky bonds did not fall hard while safe bonds did well, as is more typical of a weakening economy. Our best performing bond fund was iShares JP Morgan Em. Bond (LEMB), down just 10.73% in 2022, despite being significantly riskier than the intermediate-term top-rated government-backed mortgages, which fell more in 2022. Part of this was due to the high-dividend yield on the emerging-market bonds offered some counter to the decline in bond prices, unlike low-yield investment-grade bonds this year. The rising US dollar slipping near the end of the year helped this fund recover.

One thing investors should learn from 2022 is that more directly ‘inflation’-oriented investments can do well during rising inflation, but often become over-priced and tank when inflation fears subside. This is why we recommended the Series I bonds purchased direct from the US Government last year – they don’t trade at a premium during periods of inflationary fear. Incidentally, exchange-traded TIPS are now as good or even better priced, with a guaranteed return above inflation (not just matching) over 5-10 years, though there is still market price risk that could cause another 10%+ drop if rates go up more or inflation expectations drop which could happen in a sharp economic decline.

The only really hot area in 2022 was energy and other commodities (though not gold as precious metals category funds were down around 15% for the year). The fund we sold way too soon in late November 2021, Vanguard Energy (VDE), was up an astounding 62.86% in 2022 (after a 56.21% return in 2021). So much for fossil fuels dying out as an energy source. We could really have used that boost in 2022.

But enough about the past. The new investing game for stocks and bonds has become speculating on when the Fed will go back to the world we had all become too used to – 0% to 2% rates at or below inflation that made property and stocks the only game in town. The answer is probably quite a bit longer than anyone expects. The Fed isn’t going to cause a second boom in inflation by going back to the old game of low rates too soon, after being asleep at the wheel when inflation took off. That said, what could lead the Fed to reverse course is some sort of panic in the debt markets – stocks and property falling alone won’t do it. Such a panic would likely happen at significantly lower stock prices, so at that time, getting ahead of the next money-creation wave could be a possibility.

In the meantime, 4%+ safe yields are a good deal. The real question is how far out should these rates be locked in? T-bills at 4.3% are a welcome improvement after a decade plus of essentially no return on such investments, but they may only last two years (but not 6 months as some expect) before returning to sub-2%. The risk of buying 10-year or longer bonds (which have already come down in yield from the peaks of a few months ago) is that higher rates could mean another 10%-20% drop in bond prices.

At some point when a real recession hits, bond yields will fall, boosting bond prices and creating a good opportunity to shift to stocks that will likely be at lower prices than today.

On a positive note, the future for lower risk investors should be brighter. The trailing 10 year annualized return on a bond index fund is 0.9% — which is a little higher than money market funds and T-bills at roughly 0.6%. For most of this period inflation was low but we've still had 2.6% per year inflation largely thanks to recent trends. In other words, investors seeking safety and yield have lost 2% a year to inflation, or about 20% of their purchasing power.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)20.24%
ProShares Decline of Retail (EMTY)6.61%
Invesco CurrencyShares Euro (FXE)2.91%
Franklin FTSE China (FLCH)2.40%
Proshares Short High Yld (SJB)1.96%
Proshares Short Bitcoin (BITI)1.75%
VanEck Vectors Pharma. (PPH)1.24%
LeatherBack L/S Alt. Yld. (LBAY)-0.36%
UltraShort Bloom. Crude Oil (SCO)-1.24%
Vanguard FTSE Europe (VGK)-1.68%
Franklin FTSE Japan ETF (FLJP)-1.76%
NightShares 2000 (NIWM)-1.79%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.10%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.16%
Vanguard FTSE Developed Mkts. (VEA)-2.19%
Vangaurd All-World Small-Cap (VSS)-2.29%
Franklin FTSE Germany (FLGR)-2.62%
Vanguard Value Index (VTV)-3.30%
Homestead Value Fund (HOVLX)-3.50%
Franklin FTSE Brazil (FLBR)-4.88%
[Benchmark] Vanguard 500 Index (VFINX)-5.77%
Franklin FTSE South Korea (FLKR)-6.14%
Vanguard Communications ETF (VOX)-7.16%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)1.01%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.61%
Vangaurd L/T Treasury (VGLT)-2.28%
Vanguard Long-Term Bond Index ETF (BLV)-2.29%
Vanguard Extended Duration Treasury (EDV)-2.99%