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October 2020 Performance Review

November 6, 2020

In the three months to the end of October, the market was slightly down. Historically (almost 9 times out of 10), this correlates very well with the incumbent party losing the White House. This sort of makes gut sense: if stocks are dropping, there may be issues in the economy, and voters seek change when the economy is weak. With Biden on the edge of a win, you can chalk up another success for stocks predicting the outcome of elections. While not scientific, it's probably a better indicator than any number of expert predictions or even polling, in some cases. For the record, Hillary Clinton was leading in the polls in 2016, but the stock market was down before the election—and we all know about that surprise turnout. October was weak for both stocks and bonds.

Our Conservative portfolio declined 1.71% , and our Aggressive portfolio declined 1.19%. Benchmark Vanguard funds for October 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 2.66%; Vanguard Total Bond Index (VBMFX), down 0.61%; Vanguard Developed Mkts Index (VTMGX), down 3.73%; Vanguard Emerging Mkts Index (VEIEX), up 1.94%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.96%.

We don't want to over-analyze political correlations with stocks, but some goings-on are worth noting, especially since the stock market took a strange turn to the upside in early November, even given the oddities of this election developing results.

As for the three-month market indicator being right again, if any year would have made this indicator worthless, this was it, given the wild gyrations from pandemic shutdowns and massive stimulus programs by the White House and Federal Reserve. The recent huge climb from the abyss to new records (at least for larger cap growth stocks) was probably due for a fall back anyway.

In the days right before the election and during the election on November 3, the market started to take off—presumably on the assumption that Biden would win and that with Congress and the Senate going blue all sorts of massive stimulus programs would be passed. On top of massive Federal reserve support, stocks seem to like that. Note that the market doesn't really care much about 10 to 20 years down the road when such programs have to be paid for, or maybe the market figures we'll be inflating our way out of this mess and that could also be good for stocks, especially companies with debt.

It appears Biden is winning by only a squeaker and the Democrats seemed to have lost the chance to gain real power though the Senate, even losing seats in the House. Remarkably, the stock market took this as a great thing because it basically means all Trump-era policy is locked in place and we won't see a truly massive stimulus (just a massive one by, say, 2009 standards). This means low corporate taxes as well as low income taxes for all brackets are here to stay, at least until some expire years from now. It doesn't seem to bother anyone that this is a long-term disaster, financially speaking, with no major spending cuts or offsetting tax increases. Interest rates are heading back down, perhaps because without the truly massive spending plan that was being hatched by Democrats there is ample demand to buy just a few trillion a year in extra borrowing.

But if the market likes a Biden win, with our without full power, then it would have liked a Trump win losing power in the Senate as well. What about a Trump win with full control of both houses? Maybe the market just wanted to go up because really we are in a speculative bubble now, and without major riots in the streets or double-digit unemployment the drift is up, up, and away. This is how crashes happen.

In our portfolios, our only upside (not including short funds) last month was in small cap stocks, utilities with newly added Vanguard Utilities (VPU) up 4.89%, and—of all places—China, with Franklin FTSE China (FLCH) up 5.01%. Vanguard Small-Cap Value (VBR) gained 3.14%. Perhaps the great turnaround after years of large cap growth outperformance is upon us. With all the momentum and Covid economic benefits to big tech, this could be too soon, but then stocks tend to move before reality catches up.

We had some fairly large losses abroad as a resurgence in Covid cases leads to new lockdowns. Franklin FTSE Germany (FLGR) was down 10.28% as the formerly reasonably successful Covid fighter slipped. Europe in general was weak, with Vanguard FTSE Europe (VGK) down 5.42%. It is possible our political stalemate and slow grind to economic disaster will start hurting the dollar again and boosting foreign holdings, but with trouble abroad this may not materialize. All of our bond funds were down, but by less than 1%.

Bottom line: stocks seem to love low interest rates (actually negative adjusting for recent inflation in many cases) and huge deficit spending and couldn't care less about the longer-term problems we're creating. This could all be very wishful thinking by investors not considering the risks of political gridlock going into what could be a very dicey winter with the economy and Covid. Perhaps we did stumble into the best possible situation. Historically, stocks do best with a Democrat in the White House and 10 of the last 11 recessions happened with a Republican as president. You have to go to the 1800s to find a Republican who didn't have a recession in their first term. These patterns could be coincidences and don't seem to match the generally pro-business policies from Republicans.

Stock Funds1mo %
Franklin FTSE China (FLCH)5.01%
Vanguard Utilities (VPU)4.89%
Vanguard Small-Cap Value (VBR)3.14%
ProShares Short QQQ (PSQ)2.36%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.94%
Franklin FTSE South Korea (FLKR)-0.62%
ProShares Decline of Retail (EMTY)-1.12%
Homestead Value Fund (HOVLX)-1.25%
Vanguard Value Index (VTV)-1.82%
[Benchmark] Vanguard 500 Index (VFINX)-2.66%
Franklin FTSE Brazil (FLBR)-3.25%
Vanguard Energy (VDE)-3.47%
Vanguard FTSE Developed Mkts. (VEA)-3.55%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.73%
VanEck Vectors Pharma. (PPH)-4.86%
Vanguard FTSE Europe (VGK)-5.42%
Franklin FTSE Germany (FLGR)-10.28%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)-0.20%
iShares JP Morgan Em. Bond (LEMB)-0.38%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.61%
Schwab US TIPS (SCHP)-0.65%

September 2020 Performance Review

October 2, 2020

Recurring COVID economic fears on top of political uncertainly started to weigh on markets again. Until recently, markets had been acting as if the worst was well behind us, and it was just a question of how fast the recovery was going to be.

Our Conservative portfolio declined 2.12% and our Aggressive portfolio declined 3.29%. Benchmark Vanguard fund performances for September 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 3.80%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.08%; Vanguard Developed Markets Index Fund (VTMGX), down 2.01%; Vanguard Emerging Markets Stock Index (VEIEX), down 1.67%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 1.88%.

Our recent trades didn't help much as there was real weakness in many areas that have had the worst returns of the last decade or so, relative to US larger cap stocks. This includes small cap value, energy funds, and many emerging markets, notably newly-added Brazil Franklin FTSE Brazil ETF (FLBR). Basically, anything that was popular with investors about 10—15 years ago has had a terrible 10—15 years.

We've been adding these long-term underperformers recently and getting out of any remaining larger cap growth or tech-oriented funds. In hindsight we started this transition way too early. Energy was the only fund category down by double digits last month as oil prices weakened, as did expectations for any sort of demand recovery in the future. Our new 2020 pick Vanguard Energy (VDE) was down a whopping 14.77% in this environment. Even the dollar started to edge back, dragging on most foreign markets priced here in dollars.

The only real shining area in our portfolios is South Korea, which is booming, with a 45% return since we added it in April and a 2.42% rise last month. It wasn't enough to help our otherwise lackluster returns in this strange COVID market, where mostly U.S. tech stocks lead the way and are benefiting from the losses in the less digital economy. This issue is global, as most countries don't have our country's dominance in digital. In many ways they are more exposed to falling earnings due to COVID, even though many countries are doing a better job than us of managing the outbreak and the shutdowns.

There is a sad zero-sum game going on because of COVID. Entire industries, particularly those related to travel, are losing most of their revenues to the COVID winners. It is not even a zero-sum game, as the entire economy is smaller than it was at the beginning of the year. This is why some of these stock moves up, even with the winners, are overblown. The entire market cap should be down, along with GDP. The winners' stock prices are gaining more than the losers are losing, and it can't go on forever.

Stock Funds1mo %
Franklin FTSE South Korea ETF (FLKR)2.42%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.67%
Vanguard FTSE Developed Markets (VEA)-1.78%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.01%
Franklin FTSE China ETF (FLCH)-2.09%
Vanguard Value ETF (VTV)-2.24%
Franklin FTSE Germany ETF (FLGR)-2.82%
Homestead Value Fund (HOVLX)-2.87%
Vanguard FTSE Europe (VGK)-3.09%
VanEck Vectors Pharmaceutical (PPH)-3.66%
Vanguard Small-Cap Value (VBR)-3.73%
[Benchmark] Vanguard 500 Index (VFINX)-3.80%
Vanguard Energy (VDE)-14.77%
Bond Funds1mo %
[Benchmark] Vanguard Total Bond Index (VBMFX)0.08%
Vanguard Short Term Inflation Prote (VTIP)-0.18%
Schwab US TIPS (SCHP)-0.31%
iShares JP Morgan Em. Bond (LEMB)-1.09%

TRADE ALERT

September 16, 2020

We placed a few trades in both our model portfolios late on Friday, September 11th. The relatively minor changes were primarily to shift us out of some areas that had been hot and to add some lagging stock categories.

The rebound in stocks from the crash levels earlier this year has been a little too fast and furious, even adjusting for the low interest rates—if you can ever really adjust for low interest rates! This issue is particularly a problem with U.S. technology stocks, which are rapidly getting expensive, even beyond what incredibly successful near monopolies can be worth with near zero interest rates.

In our Conservative portfolio, we added a 5% stake in Vanguard Utilities ETF (VPU), a previous holding that has lagged recently relative to the tech-fueled stock market and is now worth buying again given its yield of around 3.4%, which should be inflatable over time and is very attractive compared to bonds today. You could get a higher yield in energy stocks (which we still own), but these represent a riskier yield. Real estate fund dividends aren't as attractive either and are possibly the most at risk of serious trouble as we possibly approach a once-in-a-generation downward adjustment to rents—at least in cities. We also dumped our 5% stake in iShares Edge Quality Factor (QUAL) after a roughly 31% gain since April. Cash-rich and low-debt companies benefit from being well positioned to manage best in a Covid-troubled economy. This positioning also means lots of tech holdings, but we don't want that exposure right now.

Specifically, in the Aggressive portfolio, we added a Brazil ETF, Franklin FTSE Brazil ETF (FLBR) to be exact, for a 6% allocation and purchased an "oldie but goodie" Utility ETF Vanguard Utilities ETF (VPU) for a 5% stake. We cut back our BRIC (Brazil, Russia, India, China) ETF iShares MSCI BRIC (BKF) from 6% to 0%, because it is now cheaper to own the countries we want to be in directly, partially thanks to the newish, very low fee, single-country ETFs from Franklin.

We also cut back our stake in Schwab US TIPS (SCHP) from 14% to 9%, because inflation expectations are rising and inflation-adjusted bonds now need pretty high inflation just to break even with regular treasury bonds. Typically, these bonds are purchased when investors are not worried about inflation, as was the case a few months ago. In fact, too high an inflation expectation can accelerate losses in a stock market crash as investors start to think that deflation is more likely. Overall, the bond market is becoming increasingly dangerous with so much money being put in by investors despite corporate bonds barely yielding more than Government debt, even with a high default risk from Covid-related economic disruptions.

We also sold our now almost nonexistent stakes (from massive declines) in an inverse leveraged Nasdaq ETF and an inverse gold mining stock ETF. Basically, we only made money by shorting oil in recent years. The Nasdaq deserved some of the increase as the world moved even more toward a plugged in Internet-based world (sadly) thanks to Covid, but it could still fall from these high levels. We need a new fresh position (which will also decline if Tesla and the other big names climb to even more ridiculous levels) with less leverage, in case we get big rebounds on the way down.

Gold mining stocks should do what they have done over the last 30 years—which is to go nowhere—and gold itself is only going up because holding money and short-term bonds is a loser position now. Covid has sent the demand for jewelry down by almost half—all the excess production has been picked up by ETFs that own gold and other speculations (future supply …). The short-term risk here is too high, especially with negative inflation-adjusted interest rates and a new gold bubble forming. Buffett's Berkshire Hathaway just bought a stake in a gold mine—even though Buffett has been a long-time critic of gold as an investment—after selling off an airline at a loss that he had only recently added to—that is how weird a world we are in at the moment.

We added an inverse offline retailers ETF as a possible good hedge against a second slide in stocks brought on by a potential fall in Covid cases. The concept is a little strange as all the retailers in the fund sell online as well has have big retail footprints, but then they could be hit with the double whammy of lost retail traffic and trouble competing with the ever-growing Amazon and other online tech giants squeezing the smaller retailers selling online.

As ETF trading is now free at TD Ameritrade (where these model portfolios are traded with real money) and basically all the other major brokers, we did some small rebalancing trades just to get our allocations back to where we want in some positions, but avoided cutting back in other areas that are up in order to avoid having too much in short-term capital gains (relative to the losses in inverse funds realized with this trade). This includes Franklin FTSE South Korea (FLKR), up around 50% since bought in our Conservative portfolio in April. In general, you almost never want to realize short-term taxable gains as no trade is worth the extra tax bite unless you have losses or could have losses elsewhere to offset the gains. Use your own tax situation and account type (IRA or taxable) to judge how much rebalancing you should do or to decide if you should hold off on some sales until short-term gains become long-term gains.

One area with a risk of future underperformance for us here is if U.S. stocks keep going up and up, notably tech stocks. By having larger foreign stock allocations we are basically avoiding tech stocks as most foreign countries have few top tech companies. In the longer run, it really depends on how much of the global economies' profits are going to be sucked up by a handful of tech giants that are increasingly in the middle of everything (so much for disintermediation) before regulations or taxes change the game significantly for these giants.

The main case for increased stock prices is almost guaranteed negative real (inflation adjusted) interest rates for years. This means Central Bankers are targeting say 2% inflation yet manipulating interest rates to around zero (some of this is just massive bond buying by the public). Losing 1%—2% of your money every year with the potential for 10%—30% hits if rates go up fast is not an appealing investment and makes even the most expensive stock make sense over time. Imagine if we had a 10% guaranteed negative real interest rate, say 0% interest rates and 10% inflation, is there any price that Apple stock would lose money over 10 years relative to bonds? Apple can just charge 10% more each year for iPhones and their cut of app sales will inflate with everything else and they could increase their dividends by 10% a year with no real change in their business. Deflation is far worse for business, and the Fed knows it.

In targeting 2% inflation with negative interest rates, the Fed creates almost limitless upside to inflatable asset prices—yet still will have trouble getting real world inflation to 2% when considering things like rents and energy and food. It would be much safer for the markets and economy to just create money and give it to people to spend and slow the Fed debt buying with newly created money or 'quantitative easing', but as creating money to spend directly is the historical recipe for rampant inflation in various countries, Central Banks are naturally scared of that strategy, but creating money that flows into investment speculation could be even more dangerous. Does it really make sense for companies to borrow their way out of the Covid mess because rates are low instead of issuing stock?

In closing, any market that pushes up a Tesla wannabe (Nikola...are you kidding me with this name?) that smells like a penny stock scam on steroids to a market value greater than Ford with no real path to profitability is a sign of a dangerous market distorted by low rates and a Robinhood-trading-app-stock-gambling culture.

August 2020 Performance Review

September 8, 2020

The bubble forming in fast-growing tech stocks — notably the handful of tech near-monopolies increasingly driving the entire stock market's returns — started to burst in September, but for August it was smooth sailing for the trillion dollar-ish market cap crew. Most stocks are still below the pre-pandemic all-time highs, but some are way, way up, driving the indexes to new highs. Interest rates crept up, hurting bonds and foreign markets benefiting from a weakening U.S. dollar.

Our Conservative portfolio gained 2.60%, and our Aggressive portfolio gained 2.71%. Benchmark Vanguard funds for August 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 7.18%; Vanguard Total Bond Market Index Fund (VBMFX), down 1.02%; Vanguard Developed Markets Index Fund (VTMGX), up 5.07%; Vanguard Emerging Markets Stock Index (VEIEX), up 2.26%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.72%.

With basically no larger cap tech stocks except for iShares Edge Quality Factor (QUAL) up 6.86% last month, our returns were supported by foreign stocks, which in general had a decent month largely thanks to a weak U.S. dollar. Inflation-adjusted TIPs bond funds did well relative to the bond market as inflation expectations picked up. If this keeps up, we may have to move to Utility stocks as a big expectation for inflation can lead to problems in the next crash and falling inflation expectations. iShares Edge Quality Factor  (QUAL) is on the short list to get sold here.

Much as they did in the late 1990s, larger cap growth stocks are dominating the market. Unlike the 1990s, other areas like value stocks and bonds are no real bargain. The S&P 500 was up 7.19% with dividends last month. This gain beat basically 100+ global fund categories except for Japan, U.S. large cap growth, and U.S. technology stocks, and consumer cyclical stocks. Of course, large cap growth and tech stocks are what is driving the S&P 500, so this is just more of the same.

The tech action is even pushing up funds you wouldn't expect to see on the tops for the month — like Convertible bond funds, enjoying a 28% one-year return. These funds often own lots of Tesla convertible bonds, which are basically trading like the stock, now that the stock price is well above the conversion price on the bond. Tesla stock recently did a 1-for-5 stock split and was worth about as much as all the other auto stocks combined — not bad for less than a 1% global market share of sales. One head scratcher among many is why the other auto stocks haven't tanked — if Tesla is the future, are we just going to be selling more high margin cars in the future such that the old car companies can keep their market caps? Somebody is going to lose big time.

While parallels can be drawn to early 2000 (which ended very badly for tech stock investors and the S&P 500 in general), there are several important differences:

  1.  Interest rates are just above 1%, not over 5%. It is not hard to finance this debt cost with earnings from a company if you did a company buyout with debt — or just took out a 30-year mortgage and used the cash to buy stocks.
  2. The earnings are largely real. Tesla and some others aside, the bulk of the big tech companies are big earners on today's eyeballs. They don't even need to grow users or come up with a revenue model.
  3. The margins are monopoly grade. Companies like Apple and Google can take a third of all money going to apps. A few weeks after a Congressional shakedown, both Apple and Google kicked off a game maker for billing consumers directly and not cutting in the two phone operating system giants for their usual cut . Amazon is not far off from having a piece of most online sales. Facebook is selling ads off everybody's social media content and not cutting in content creators.
  4. There may not be competition for many moons because possible competitors will get bought out or crushed. Google couldn't beat YouTube, so they bought it. Facebook bought Instagram. Somebody is probably going to buy TikTok.
  5. The Covid pandemic is creating a tech dystopia where we all live in our houses and live off the internet. This has been building slowly since the 1990s and accelerated with smart phones, but this could be the last breath of the bricks-and-mortar economy. Sad!

 

It is a golden era of tech, but this is not a 'this time it's different' point to rationalize trillion dollar market caps. The boom can still collapse just out of fear in investors who recently bought in with leverage, but also longer term because there is only so much profit a handful of companies can squeeze out of the economy before global governments start turning up the heat. This regulatory shakedown could take many forms, but higher taxes to help pay for the trillions in Covid economic support on top of already lofty government debt piles seems probable.

Stock Funds1mo %
[Benchmark] Vanguard 500 Index (VFINX)7.18%
FTSE Germany (FLGR)7.04%
iShares Edge Quality Factor (QUAL)6.86%
Franklin FTSE China (FLCH)6.46%
Homestead Value Fund (HOVLX)6.37%
Franklin FTSE South Korea (FLKR)5.61%
Vanguard FTSE Developed Markets (VEA)5.17%
[Benchmark] Vanguard Tax-Managed Intl. Adm. (VTMGX)5.07%
Vanguard Small-Cap ETF (VBR)4.63%
Vanguard FTSE Europe (VGK)4.31%
Vanguard Value ETF (VTV)4.18%
iShares MSCI BRIC Index (BKF)4.18%
VanEck Vectors Pharmaceutical (PPH)2.40%
[Benchmark] Vanguard Emerging Mkts (VEIEX)2.26%
Vanguard Energy (VDE)-0.62%
Direxion Gold Miners Bear 3X (JDST)-6.67%
Proshares Ultrashort QQQ (SQQQ)-28.21%
Bond Funds1mo %
Vanguard ST Inflation Protected (VTIP)1.11%
Schwab US TIPS (SCHP)0.91%
iSHARES JP Morgan Em Bond (LEMB)-0.07%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.02%

July 2020 Performance Review

August 4, 2020

With interest rates near zero and property owners facing potentially massive problems with occupancy and rent collection, stocks are becoming the only game in town. But it is an increasingly expensive game to play. The U.S. economy shrank by around 10% this past quarter, taking us back to the GDP levels of about five years ago after adjusting for inflation, but the stock market continues to rise to almost record highs. While it is common for stocks to move ahead of the economy, both down and up, there are no previous cases of GDP being this far below its all-time high but stocks near all-time highs.

Our Conservative portfolio gained 2.05% and our Aggressive portfolio gained 2.72%. Benchmark Vanguard funds performed as follows in July 2020: Vanguard 500 Index Fund (VFINX), up 5.64%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.55%; Vanguard Developed Markets Index Fund (VTMGX), up 2.64%; Vanguard Emerging Markets Stock Index (VEIEX), up 8.38%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 4.39%.

Our strongest areas were emerging markets, notably China, with FRANKLIN FTSE CHINA (FLCH) up 9.46%. The now large-cap-tech-dominated S&P 500 did better than almost everything else worldwide, with particular weakness in energy stocks in our portfolios, as VANGUARD ENERGY (VDE) fell 4.19%. As for bonds, a falling dollar and a continued rebound in risky debt helped iSHARES JP MORGAN EM BOND (LEMB) climb 3.78%, while our safer bond fund VANGUARD ST INFLATION PROTECTED (VTIP) gained just 0.76%, which was only half the return of the overall bond market last month.

The stock market's total value is about double the new lower annual GDP of $19.4 trillion. This is a record level, in what is one of Warren Buffett's snapshot measures of valuation of a national stock market. This ratio of market value to GDP is lower in every other country.

The previous high for this ratio was about 150%, in 2000, followed by around 140% in 2007. In both cases, slides of roughly 50% in stock prices followed. The 2007—09 slide took the stock market down to around 90% of GDP, which would equate to maybe a 55% slide in the market from current levels — if the economy stops shrinking. But such a slide in stocks is a long shot, because during the last two crashes you could still earn a decent return in bonds, whereas today stocks are likely your only chance of positive inflation-adjusted returns. Such a drop would be more likely if rates were to climb fast hitting bond prices hard.

At this point the Federal Reserve isn't so much creating long-term future earnings growth so much as removing short-term downside. We saw this explicitly a few months ago when it started supporting bond prices across the board as investor panic selling began. This support is the main reason to own bonds at all, with the risk of a slide due either to interest rates going back up or corporate (and maybe state) defaults rising in a weak economy. The Fed has your back and will support prices, directly. It is doing much the same thing with stocks, indirectly for now, which is why a 1.75% yield in the S&P 500 — which could be cut in half or more at this rate of economic trouble — is not shabby at all, if you remove the risk of losing more than maybe 25% in the short run.

Imagine if the Fed said it would print money and buy stocks if they go down 25%, take them back to their old highs, then slowly sell. What would the correct price for stocks be? With 1% interest rates, perhaps double their current levels, as stock dividends grow (most of the time) and are taxed favorably.

The only reason NOT to own stocks, with the Fed covering your losses and downside risk, is opportunity cost: what could you have earned elsewhere? To do better somewhere else would require interest rates to rise, but the Fed has already said in essence that it will not let rates go up either. So you are back to stocks again. The Fed's behavior could cause inflation, which is bad for bonds and maybe for the U.S. dollar, but not necessarily bad for stocks or real estate. But other major countries are in this same boat unless they can avoid longer-term lockdowns and continuing monetary support. The real risk is still deflation, such as Japan experienced after its 1980s bubble. But with aggressive money creation, is that possible? Stagflation is more likely: higher inflation with slow economic growth.

Investors aren't buying into this market recovery, and really haven't since the 20% drop in stock prices in late 2018, which also rebounded quickly. Over the last couple of years, around $400 billion has departed stocks for bonds. These days investors are putting tens of billions into bonds each week, with near guaranteed low returns, and pulling as much out of stock funds. Normally this is a huge positive for future stock prices and a huge negative for bonds, but these are not normal times. Much of this is likely just rebalancing because stocks are climbing faster than bonds, and much of it is on autopilot in index funds these days. But there were signs of panic selling of stocks on the way down, and huge outflows from bonds (the highest on record, it seems) when they briefly tanked in March. True rebalancing would have seen money go into stocks and probably into bonds, and out of cash.

For reference, in 2000 everybody was gaga about U.S. stocks. There was about 20% more investor money in stocks relative to bonds and cash, and all the new money was going into U.S. stocks. This was the beginning of poor returns in stocks and very good returns in bonds. In fact stocks still haven't caught up with long-term Treasury bonds purchased in 2000, and might need another decade or more to do so. This highlights the problem with buying stocks at valuations near all-time highs.

The 20-year annualized return on the Vanguard 500 stock fund Vanguard 500 Index Fund (VFINX) is around 5.8%, but it is a whopping 7.7% for the Vanguard Long Term Treasury fund (VUSTX) — a huge difference over 20 years. The chance of stocks underperforming long-term Treasuries over the next 20 years is about zero, unless we go into a Japan-style bubble deflation period, which is possible. But for stocks to catch up will require a big spread over bond returns for years to come.

At this point, at best, sluggish earnings growth (inflation-adjusted, after tax) is pretty much going to be here for years. Even with a relatively fast return to semi-normalcy in the global economy, paying down the trillions of borrowed money will require some mix of tax increases and less borrowing by governments worldwide, which by itself should wipe out much of the already slow growth rates in recent years.

The bottom line is that stocks are not a good deal at these levels, but cash, bonds, and real estate are worse. Sharp drops in stock prices, even if not to historically good valuations, are opportunities to buy, but from all-time highs, future returns will be low.

Stock Funds1mo %
FRANKLIN FTSE CHINA (FLCH)9.46%
ISHARES MSCI BRIC INDEX (BKF)9.35%
[BENCHMARK] VANGUARD EMERGING MKTS STOCK IDX (VEIEX)8.38%
FRANKLIN FTSE SOUTH KOREA (FLKR)5.80%
[BENCHMARK] VANGUARD 500 INDEX (VFINX)5.64%
ISHARES EDGE QUALITY FACTOR (QUAL)4.95%
VANGUARD VALUE ETF (VTV)4.54%
VANGUARD SMALL-CAP ETF (VBR)3.77%
FRANKLIN FTSE GERMANY (FLGR)3.72%
VANGUARD FTSE EUROPE (VGK)3.66%
[BENCHMARK] VANGUARD TAX-MANAGED INTL ADM (VTMGX)2.64%
VANGUARD FTSE DEVELOPED MARKETS (VEA)2.63%
HOMESTEAD VALUE FUND (HOVLX)2.57%
VANECK VECTORS PHARMACEUTICAL (PPH)1.63%
VANGUARD ENERGY (VDE)-4.19%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-21.56%
DIREXION GOLD MINERS BEAR 3X (JDST)-36.45%
Bond Funds1mo %
ISHARES JP MORGAN EM BOND (LEMB)3.78%
SCHWAB US TIPS (SCHP)2.25%
[BENCHMARK] VANGUARD TOTAL BOND INDEX (VBMFX)1.55%
VANGUARD ST INFLATION PROTECTED (VTIP)0.76%

June 2020 Performance Review

July 2, 2020

The V-shaped recovery is here—long live the V-shaped recovery! The main problem is that the actual economy and COVID-19 pandemic are not on a V-shaped recovery path—just the stock market. Even with its very brief but significant slide from the top (almost 40% for the Dow, top to bottom) we did not approach the valuations seen at the bottom of the last two major slides in stocks, in 2002 and 2009—not even close. But then, we have 0.7% interest rates and far more money sloshing around.

Our Conservative portfolio gained 1.64% and our Aggressive portfolio gained 1.16%. Benchmark Vanguard funds for June 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 1.99%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.70%; Vanguard Developed Markets Index Fund (VTMGX), up 3.40%; Vanguard Emerging Markets Stock Index (VEIEX), up 7.16%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.01%.

The three-legged stool of this sharp market rebound is: 1) low interest rates; 2) massive government support, and; 3) a "this too will pass" mentality. All three are actually pretty solid reasons for stocks to rebound, until something goes wrong and one or more of them goes away. If stocks weren't risky in the short run, the Dow would have hit 50,000 years ago.

You almost can't overestimate how much of a boost low interest rates are to stocks. If government bonds pay less than 1% per year over 10 years it is almost impossible to underperform that low benchmark with stocks, from almost any starting valuation. The danger is some sort of change; either a rise in rates or a serious drop in stock valuations or a long-term move down in economic growth, or even deflation. If low rates alone guaranteed stock returns, Japan would have had better stock market performance for much of the last couple of decades.

The current support from the Federal Reserve and actual fiscal spending in a few short months is far beyond the levels we saw during the years of financial crisis over a decade ago. Paying it all back, if we pay it back, should be a serious drag for years to come. Adding insult is the clearly half-baked nature of the support and the likely widespread economic waste and abuse of massive stimulus programs being thrown together.

Issues such as those already in retirement collecting Social Security receiving $1,200 stimulus checks, collectively totaling more than the GM bailout (before most of it was paid back), that seemingly angered much of the country, are getting no attention. It is probably because the alternative—mass bankruptcies and a 1930s-style Great Depression—is so scary that erring on the side of excess spending is comforting.

This stock market has been through many, many crises worse than COVID-19, including worse pandemics. One thing that has become apparent is that if you wait too long, you will miss out. Stocks move up well before the troubles are gone, so you basically have to take on that risk that things won't get better. It is possible this has gone a little too far, because things might not be getting better soon enough to prevent the next Great Depression, or at least to stop the trillions of dollars in support from being wound down anytime soon.

This whole stock market rebound seems to be riding on the death rate from the recent resurgence in cases and hospitalizations. Sharply rising daily case numbers has already slowed the reopening of many states and the global economy. If the death rate takes off next, we'll be back to costly full shutdowns for months to come. On the other hand, if the death rate more or less plateaus or even continues to decline while cases continue to rise or remain high, then from an economic perspective this is a win of sorts, as we could have business as semi-usual. This assumes there is a benefit in herd immunity, which hasn't been proven yet.

Even the worst case—no immunity gained from catching and surviving the virus and no vaccine—will lead to a new economy in the long run, with different companies selling different goods and services with a different kind of workforce. It could be a long, painful path to get to point B, but investing in stocks will still work out. But it could be a very long W-shaped recovery. Nobody wants to be in 0% cash but nobody wants to lose 50% fast because over 10 years stocks should beat bonds.

Perhaps the only reason not to be heavy in stocks is the chance something doesn't work out and we have more of a W (or even a VW) recovery with opportunities to get more for less. This can be a tough game to time, with lots of investors looking to move the trillions sitting in cash and bonds back into stocks and a high opportunity cost of not being in stocks. This is unlike the last two 50% drops in stocks, where bonds offered good alternative returns. The likelihood of getting anywhere near the valuations of the last crash bottom is slim to none, in the absence of a full bore multiyear depression.

In our own portfolios and the global markets, riskier investments performed well, or at least those areas that have been weaker on the way down. Our biggest winner was Franklin FTSE China ETF (FLCH), up 7.81%, slightly ahead of a generally strong month for emerging markets in general, which took Franklin FTSE South Korea (FLKR) and iShares MSCI BRIC (BKF) up 7.12% and 6.99% respectively. Europe did well. Besides shorting, there was weakness in value-oriented or lower risk U.S. stocks. We saw flat to negative returns in several holdings, such as iShares Edge Quality Factor (QUAL), Homestead Value (HOVLX), and VanEck Vectors Pharmaceutical (PPH).

There was surprising continuing strength in larger cap tech stocks, most of them at new highs and really the driving force in the U.S. market for this rebound. Most tech companies are benefiting from this stage of COVID-19 as the stay at home, work and live lifestyle some people are begrudgingly enjoying is conducive to consuming the services of the top tech giants. It could be the final nail in the coffin of those bricks and mortar businesses not finished off by the Internet thus far.

Or we could have a backlash against the homebound life when COVID-19 eventually goes away. People may decide they have had enough of staring at phones, tweeting, and ordering delivery, and want to return in droves to breathing that sweat aerosol-filled air in stores, restaurants, and airplanes.

The bond market was only slightly higher as rates remained low. But there was strange strength in high-yield muni bond funds, which seem to be at risk of disaster as the sheer cost and economic impact to state and local governments is incalculable.

Stock Funds1mo %
FRANKLIN FTSE CHINA (FLCH)7.81%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)7.16%
Franklin FTSE South Korea (FLKR)7.12%
iShares MSCI BRIC Index (BKF)6.99%
FRANKLIN FTSE GERMANY (FLGR)5.08%
VANGUARD FTSE EUROPE (VGK)3.94%
VANGUARD FTSE DEVELOPED MARKETS (VEA)3.50%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.40%
[Benchmark] Vanguard 500 Index (VFINX)1.99%
VANGUARD SMALL-CAP ETF (VBR)1.58%
iSHARES EDGE QUALITY FACTOR (QUAL)0.18%
Homestead Value Fund (HOVLX)-0.39%
VANGUARD ENERGY (VDE)-0.79%
VanEck Vectors Pharmaceutical (PPH)-1.64%
Vanguard Value ETF (VTV)-1.78%
DIREXION GOLD MINERS BEAR 3X (JDST)-18.91%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-19.83%
Bond Funds1mo %
Schwab US TIPS (SCHP)1.11%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.70%
VANGUARD ST INFLATION PROTECTED (VTIP)0.68%
iSHARES JP MORGAN EM BOND (LEMB)0.44%

May 2020 Performance Review

June 3, 2020

If your only news was stock prices, you'd never suspect that America was slowly and not very carefully emerging from one crisis only to quickly slide into another. Another headscratcher is how our stock market is currently down less for the year than other countries that have fared better during the health pandemic and economic shutdown.

In May our Conservative portfolio gained 3.03% and our Aggressive portfolio gained 2.65%. Benchmark Vanguard funds ended the month as follows: Vanguard 500 Index Fund (VFINX), up 4.76%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.54%; Vanguard Developed Markets Index Fund (VTMGX), up 5.56%; Vanguard Emerging Markets Stock Index (VEIEX), up 2.33%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 4.18%.

Much of the rebound has been in the same giant tech companies that have dominated the markets in recent years. This makes some sense, since between the COVID crisis and the riots, staying home Livin' la Vida Aburrido (living the boring life…sorry, Ricky Martin, especially because I'm unsure of my Spanish here) seems to be the new normal. And what better way to spend the time than using the internet and various tech companies to deliver every form of good and service we could possibly imagine?

It makes one wonder if artificial intelligence, or AI, is already here and already taking over the world, with the first major attack on humanity being to figure out a way to keep us in our homes using more technology and destroying the physical world so the robots don't have to do it.

The main explanation for the positive stock action is optimism. The alternatives in bonds and cash are very bleak, with essentially guaranteed negative inflation-adjusted returns for years ahead. The trillions of dollars that have accumulated globally have to earn a return, even if it turns out to be a high-risk, low return. It is possible that this is the darkest period just before the dawn, and this all goes away fast, leading to strong earnings growth with the support of low interest rates and a trillion in new spending. The world's shortest depression then disappears as quickly as it appeared. Poof.

It hasn't helped so far, but it is possible that this was the month foreign markets started to outperform our market, if our economy remains in a semi-shutdown induced by COVID-19 and rioting while others reboot. Even if we have the best tech companies to plug in to, there could still be a drop in our dollar as our low interest rates, scary economy, and sloppy government pandemic spending catches up to us. So far, this move could be merely that these foreign markets have more to go to return to old highs than a sea change in investor sentiment.

These two crises are probably related. A depression — even a temporary depression created to fight a health crisis — creates a fertile environment for revolution or worse. One side effect of the response which makes it unsustainable even if it leads to better health outcomes is that society has deemed some workers (mostly on lower wages) to be doing essential work, while others get to stay safe at home, having food delivered and Netflixing.

A problem that catches your attention in the moment can then blow up. The media thrives on your attention and on sensationalism. It isn't concerned with actual probabilities and boring long-term problems so much as interesting anecdotes.

Both sides are guilty of focusing on individual examples. It leads to the belief that drugs with side effects that won't help cure a disease are worth trying, as well as the belief many healthy young people are dying from a virus. This is because readers are more interested in such stories than in news about a new drug flop or another death of a 95-year-old. The media has a way of making some problems seem worse than they are and making other, larger problems seem ordinary. Airline crashes versus drunk driving. This is a troubling area, as it is often the large, dull, long-term problems that are easier to fix for better outcomes for more people.

As foreign non-emerging markets did well last month, many of our stock funds had a good run, but the drag of emerging markets and sub-1% return bonds kept our returns at the so-so level. At the top of the heap was our new German stock ETF Franklin FTSE German (FLGR), up 9.64%, with a big performance spread over the rest of Europe. Germany seems to be managing its economy and health crisis well, relative to the rest of Europe.

There are still serious dangers in European markets stemming from the problems of having a single currency during a crisis. It may require magical thinking by central banks in the form of money creation policies looser than we have ever seen, at least on this side of broken economies with 1,000% inflation.

Call it MMT light, after the 'modern monetary theory' that claims you can just print money to pay bills until you have inflation, and need not worry much about borrowing and taxing (don't worry about it, sweetheart). Whatever is done, it will be harder to pull off in a region that shares a currency. Only a single country can get away with such an adventure into the monetary unknown.

All this fear and money mischief is boosting gold and killing our gold stock short, but if we actually get inflation we're protected somewhat with our new TIPS bonds funds. The possibility of real deflation is what investors should worry about.

At the bottom of our non-short fund heap was Vanguard Energy (VDE), up just 1.66% after a strong rebound previously, as oil prices seem to have been boosted artificially back up to levels that can prevent a massive extinction event in the U.S. oil business. If oil prices go any higher we may short crude oil again, while keeping this stock fund that owns actual oil companies.

In bonds, only our riskier bond fund iShares JP Morgan Emerging Bond (LEMB) delivered returns over 1%, with a 5.81% pop, though it is still down since purchase this year. Elsewhere in funds almost nothing was way up or down this month, with the best fund categories up around 10% and the worst down just under 2%. That near 2% drop was in long-term government bonds, so we're glad we're out of that category for now.

Stock Funds1mo %
FRANKLIN FTSE GERMANY (FLGR)9.64%
VANGUARD FTSE EUROPE (VGK)5.84%
iSHARES EDGE QUALITY FACTOR (QUAL)5.62%
VANGUARD FTSE DEVELOPED MARKETS (VEA)5.58%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.56%
Franklin FTSE South Korea (FLKR)4.96%
VANGUARD SMALL-CAP ETF (VBR)4.80%
[Benchmark] Vanguard 500 Index (VFINX)4.76%
VanEck Vectors Pharmaceutical (PPH)4.52%
Homestead Value Fund (HOVLX)4.48%
Vanguard Value ETF (VTV)2.88%
iShares MSCI BRIC Index (BKF)2.72%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)2.33%
FRANKLIN FTSE CHINA (FLCH)1.71%
VANGUARD ENERGY (VDE)1.66%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-18.57%
DIREXION GOLD MINERS BEAR 3X (JDST)-27.14%
Bond Funds1mo %
iSHARES JP MORGAN EM BOND (LEMB)5.81%
VANGUARD ST INFLATION PROTECTED (VTIP)0.85%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.54%
Schwab US TIPS (SCHP)0.49%

April 2020 Performance Review

May 3, 2020

Stock and bond prices rebounded sharply as the trillions in Federal Reserve monetary and government fiscal spending cannons hit the market. If throwing money at the fast weakening economy turns out to be a great solution, we will win this war. If not, unfortunately we'll just have a short-term boost and a long-term mess of massive debt on top of a semi-permanently Coronavirus-slowed economy. Either way, April was a great month to pretend nothing was wrong and just own riskier assets, notably the same handful of mega cap growth stocks that have been increasingly driving stock prices recently.

Our Conservative portfolio gained 5.75% , and our Aggressive portfolio gained 5.61%. Benchmark Vanguard funds for April 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 12.82%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.69%; Vanguard Developed Markets Index Fund (VTMGX), up 7.67%; Vanguard Emerging Markets Stock Index (VEIEX), up 9.29%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 8.75%.

US growth stocks were the best place to be globally last month, with the S&P 500 beating around 85% of fund categories. In our own portfolios, only our new energy fund Vanguard Energy (VDE) and our new small cap value pick Vanguard Small Cap ETF (VBR) beat the S&P 500 last month, with a 32.21% and 13.11% return respectively. Many hard-hit areas rebounded the sharpest, perhaps foolishly, from the depths of the crash. Our shorts were a disaster, and all our new foreign stock funds did well in general, only not compared to US stocks. Our portfolios would benefit from the US dollar weakening, which would push up foreign stock returns to US investors.

Our more recent trade this year largely took us out of longer-term and corporate bonds except for inflation-adjusted government bonds. We do have a riskier allocation to iShares JP Morgan Emerging Bond (LEMB) that was up 2.48% last month, though it was still down since first purchased at the end of February. Unfortunately, the Federal Reserve's massive support of the debt markets didn't extend directly to foreign risky bonds, just US bonds. US corporations seem to have the substantial backing of the government, but you can't say the same for emerging market debt right now.

How substantial? A few days ago you could barely see any damage to investment-grade corporate US bonds for the year after a 5% up month — a far cry from a few weeks ago, when even some municipal money market funds were on the edge of collapse. Considering trillions in investment-grade corporate debt could, realistically, default if this economic situation doesn't go away soon, current pricing in bonds is very optimistic about either continued unlimited support or a quick return to normal.

Considering our Depression-level unemployment numbers, a thing of wonder is the fact that the S&P 500 (as of May 1) is now down just over 11% for the year (and about 16% from the peak). It could simply be that investors remember the 2008 crisis, when slower-moving and relatively small (comparatively) double-barreled Federal Reserve and government spending eventually worked, and it was a heck of a buying opportunity (from the 50% down mark at least).

Under this lens of "been there, done that," we won't see a 50% drop from the top like the last crisis as too much money wants to catch the buying opportunity. It could just be the realization that bonds and cash are going to yield very little or negative for a long, long time — yet with crisis-era default risks — and stocks are the only game in town for the massive amount of money in the global economy (less massive now) that needs to invest. Basically, you are being forced into the risk game whether you like it or not because the alternative is less-than-zero returns after inflation. Do you want some upside with a high likelihood of a 25—50% drop in the short run, or no upside and a high likelihood of a 30% drop over 5—10 years adjusting for inflation?

Warning signs that more trouble is coming soon include what seems to be a credit crunch building for tapped-out consumers. Banks are fast getting out of the HELOC or home equity line of credit business, and credit card companies are cutting available credit. You can't blame them — they don't want to see epic defaults from those living off credit as incomes have plunged.

As for the various government support programs — notably the PPP loans — poor execution and bad design are leading to delays and apparent or borderline fraud. Publicly traded companies that could sell more stock (among other options) for money are borrowing through this small business facility because of the favorable partial grant and low-rate nature of the financing. This could anger lower-wage workers already nearing the end of their collective rope as society has deemed their (now risky) work essential. If this situation doesn't start going away fast, the only way stock prices are going to be down just 11% for the year is if we get inflation, which is a possibility if we keep losing production capacity and sending checks in the mail to seniors already on a guaranteed income stream, rather than the actual increasingly desperate workforce. If entry level workers voted in the numbers of Social Security recipients, this would likely not be the case.

Stock Funds1mo %
VANGUARD ENERGY (VDE)32.21%
VANGUARD SMALL-CAP ETF (VBR)13.11%
[Benchmark] Vanguard 500 Index (VFINX)12.82%
Homestead Value Fund (HOVLX)11.74%
Vanguard Value ETF (VTV)11.65%
FRANKLIN FTSE GERMANY (FLGR)10.40%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)9.29%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)7.67%
VANGUARD FTSE DEVELOPED MARKETS (VEA)7.02%
iShares MSCI BRIC Index (BKF)6.62%
VANGUARD FTSE EUROPE (VGK)6.45%
FRANKLIN FTSE CHINA (FLCH)5.14%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-40.31%
DIREXION GOLD MINERS BEAR 3X (JDST)-57.51%
Bond Funds1mo %
iSHARES JP MORGAN EM BOND (LEMB)2.48%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.69%

Trade Alert

April 7, 2020

We executed trades in both portfolios on April 3 (just over one month after our previous trades on February 28th) to cut way back on corporate bonds and deal with the cash from a liquidated inverse 3x oil ETF that the fund company shut down on March 27. This ETF returned around 90% since our buy at the end of February and at least offset huge losses in our inverse gold miners ETF (which declined significantly even though gold mining stocks were down in March). So wild were the oil swings in March that at one point when the Dow was in freefall on March 19, we were up about 379% from our buy, which did briefly offer a performance offset to our declining stock funds.

Right now, corporate bonds have far more downside than upside. If we're going to take double-digit decline risk, we want more upside. While it is possible that the Fed can make this debt problem go away (or at least get lucky if we can reopen the economy sooner rather than later), there is also a chance of either serious corporate defaults or inflation resulting from distributing trillions to everyone in desperate need yet allowing production to drop. More demand, less supply is not a good mix.

The safe move with bonds is inflation-adjustable government debt or Treasury Inflation Protected Securities (TIPS). In general, we don't like this innovation because the government invented these bonds to save the treasury money, not to reward investors. Bond investors have historically required an irrational premium to own regular government debt because of the risk of inflation, a hangover from the 1970s. As we have said for years, there is not much risk of inflation above 2%, and your real danger is deflation, like in the Great Depression.

This is why regular government bonds have beat TIPS for years. That said, TIPS won't get stung much if we get depression-grade deflation from these levels (they don't pay a negative inflation adjustment, although they should). They have already underperformed as inflation expectations (correctly) have come down in this crisis, as they did in 2008. We still have some significant credit risk with our recently added emerging market bonds in case we walk away from this crisis—and the returns should be better than U.S. corporate debt in that situation.

The bulk of the trades are getting out of bond funds and into two TIPS ETFs: Vanguard Short-Term Infl-Prot Secs ETF (VTIP) and Schwab US TIPS ETF (SCHP). We are also adding a pharmaceutical ETF, mostly because they have underperformed for years and should do well in a coronavirus-slowed economy, and generally won't have trouble making debt payments (though many drug companies have lots of debt). There are some risks the government could crack down on pricing.

In our Conservative portfolio, we are adding iShares Edge MSCI USA Quality Factor ETF (QUAL), which hasn't done any better than the S&P 500 but in theory may be positioned to benefit as riskier competitors fail and are acquired by stronger players, sort of like what happened in banking in 2009. That said, these types of ETFs that try to screen for success—so-called smart beta funds—are generally bad ideas compared to the S&P 500. We also added tiny Franklin FTSE South Korea ETF (FLKR) in our continued effort to shift to countries that seem to be managing the crisis better or have more financial resources available to stimulate the economy. Somebody is going to come back online fully and fill orders, and it isn't looking like that will be us, for a variety of reasons.

In summary, we are increasing our stock risk (as we typically do during big drops), yet decreasing some of our bond credit and duration risk, and shifting more to foreign stocks that could recover faster.

March 2020 Performance Review

April 7, 2020

Ouch. The outlook for the global economy darkened amid the temporary (but not temporary enough) shutdown. Stocks tanked everywhere. At one point, the Dow was down almost 40% since the highs of mid-February, and all the gains since Trump's inauguration were destroyed. When the immense size and scale of the bailout took shape, the market took off—at one point going up around 20% from the Dow low, creating (in theory) a new bull market. Even with the rebound, as of the end of March, the S&P 500 was down around 20% for the year.

Our Conservative portfolio declined 10.98%, and our Aggressive portfolio declined 14.47%. Benchmark Vanguard funds for March 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 12.36%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.59%; Vanguard Developed Markets Index Fund (VTMGX), down 15.52%; Vanguard Emerging Markets Stock Index (VEIEX), down 17.52%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 9.75%.

Nobody knows how long the economy will be shut down. The prognosis for reopening looks grim. If the virus numbers get worse, we'll stay shut down. If they plateau, it will look like more shutdown is needed; if they go down, it will look like the shutdown is working and should be maintained. Even if the numbers fall, reopening the economy seems like a recipe for the number of cases to climb again. There is no apparent path to a functioning economy before the bills are way past due.

Unfortunately, the global economy has morphed into a highly leveraged machine—sort of like owning stocks on margin. You can get better growth as low interest rates help finance growth, but you can't slow down, because the debt payments will become impossible to make with falling revenues.

It is a bad sign that Warren Buffett just sold some of his airline shares after recently buying more a few weeks before. In theory, he should be deploying his truckloads of cash to consider taking over a viable travel-related company that just needs cash to get through the mess. He seemed more optimistic in the 2008 housing crash.

At this stage, our own portfolio changes haven't helped. While we are still down less than the stock market in 2020 (about 56% of the drop for the Conservative portfolio and ~85% for the Aggressive portfolio), last month wasn't very impressive. Our shorts didn't work out as a group, largely because 3x inverse funds don't work in the short run (or the long run for that matter) if there is a sharp reversal, even when our call was correct. In March oil, the Nasdaq and gold mining company shares were all down. Unfortunately, we lost money in two out of the three short funds here. We don't like 3x funds, but the 1x funds don't get enough trading volume or assets to use because day traders prefer the 3x leverage.

Surprisingly, our Conservative portfolio was hit hard. With no shorts in this lower-risk portfolio, bonds and safer stock funds would have had to do risk reduction, and didn't. Only VANGUARD SHORT-TERM BOND (BSV) was up slightly, while our other bond funds had too much credit risk for this market. Value funds did worse than the S&P 500; energy was clobbered, with VANGUARD ENERGY (VDE) down 36% for the month; and foreign funds generally declined more than the S&P 500.

Bonds more or less stopped offsetting downside in stocks with gains, which we have discussed as a risk in recent months as rates plunged to near zero. We should have kept the government bond funds one more month, though at one point in March, they were down significantly before the Fed engineered a bond market bailout. Worse, riskier debt not backed by the government was hit hard.

This wasn't just junk bonds and other higher-risk corporate debt, but short-term investment-grade bonds. You will see this most severely in VANGUARD SHORT-TERM CORP. BOND (VCSH), which was down 3.48% for the month. VANGUARD SHORT-TERM BOND (BSV) owns mostly government debt (which was up) along with corporate debt, and did relatively well. These performance figures for the month don't capture the mid-month slide that took these and many similar funds down 10% or more. This short-term corporate bond fund without the government debt — which only yields just under 3% — slid just over 13% in a few days in the early part of the month as investors panic-sold bonds. This was particularly bad in bond ETFs, which quite frankly are a bad idea in bad times. The underlying value of the fund assets didn't even fall by more than 10%, and if you owned the same portfolio in a traditional open-end fund format, this slide in shorter term bonds was not as severe—it was a market price issue more than an underlying bond price issue. We should have known better, as for maybe a decade , we've been harping about how there's too much money in short-term bond funds.

By our own research, this panic almost took out some municipal money market funds, sort of like in 2008 when a large money market fund "broke the buck," or the $1 price, because of losses on Lehman debt in the portfolio.

Before this panic completely took over, the Federal Reserve stepped in and hired one of the largest asset managers to basically support bond prices, including ETF shares directly. It worked. So far. Ignoring the issue that the government is creating money in the trillions and giving it to Wall Street to shore up their own bond and ETF businesses from disaster, this is not really sustainable in the long run. Corporate and municipal bond prices should be lower: there is heightened risk of default with limited revenues coming in due to the shutdown. We are pretending this will all go away soon—and it may. But it may not, and that means lots of investment-grade debt is not really investment-grade anymore. It's good for the Fed to stop a panic, but not to artificially overvalue distressed assets.

Riskier bonds had a bad month, with an 11.95% slide in our newly added iSHARES JP MORGAN EM BOND (LEMB). That was to be expected in a terrible month for risky assets in general. More of a surprise was the 7.91% slide in Dodge & Cox Global Bond Fund (DODLX), which like many bond funds has been taking on a little too much risk in the bond market to boost yield.

The basic trouble with our end-of-February trade was that there was a little too much risk, given the (in hindsight) early stage of this global market crisis. That said, somewhere between here and 50% down in the market, expect to see these portfolios move up in risk and, in the Aggressive portfolio, closer to 100% stocks, as we did in 2008—09.

Stock Funds1mo %
PROSHARES ULTRAPRO 3X SHORT OIL (OILD)89.46%
FRANKLIN FTSE CHINA (FLCH)-7.27%
[Benchmark] Vanguard 500 Index (VFINX)-12.36%
HOMESTEAD VALUE (HOVLX)-14.28%
VANGUARD FTSE DEVELOPED MARKETS (VEA)-15.19%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-15.52%
ISHARES MSCI BRIC (BKF)-15.53%
VANGUARD VALUE (VTV)-15.58%
VANGUARD FTSE EUROPE (VGK)-16.72%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-16.84%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-17.52%
FRANKLIN FTSE GERMANY (FLGR)-18.05%
VANGUARD SMALL-CAP ETF (VBR)-25.02%
VANGUARD ENERGY (VDE)-36.39%
DIREXION GOLD MINERS BEAR 3X (JDST)-79.67%
Bond Funds1mo %
VANGUARD MORTGAGE-BACKED SECURITIES (VMBS)1.32%
VANGUARD SHORT-TERM BOND (BSV)0.45%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.59%
VANGUARD LONG-TERM BOND (BLV)-1.94%
VANGUARD SHORT-TERM CORP. BOND (VCSH)-3.48%
SPDR BLOMBERG INTL TR BOND (BWX)-3.76%
DODGE & COX GLOBAL BOND (DODLX)-7.91%
iSHARES JP MORGAN EM BOND (LEMB)-11.95%

February Performance Review

March 5, 2020

It is starting to look as if the next Black Swan for the economy and stocks is the new coronavirus making its way around the world. In February the stock market behaved like in the 2007—09 financial crisis. The 10% drop from the peak was about the fastest on record for stocks. As we have been running our portfolios on the low risk side for quite some time, going into this mini-crash we performed relatively well.

Our Conservative portfolio declined 1.78%. Our Aggressive portfolio declined 3.03%. Benchmark Vanguard funds for February 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 8.24%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.71%; Vanguard Developed Markets Index Fund (VTMGX), down 7.56%; Vanguard Emerging Markets Stock Index (VEIEX), down 3.71%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.80%.

The most startling action was actually in bonds. The decline in interest rates that started in late 2018 rapidly accelerated, leaving the U.S. with 10-year government bond yields at around 1%. We've previously discussed the possibility of our bond market heading to European and Japanese interest rate levels. These regions have long had rates of zero percent and below because of low economic growth, among other issues.

This 'How low can you go?' possibility was one reason we continued to own long-term investment grade bond funds. This helped our portfolios to avoid much of the downside last month, but it is now necessary to find alternative options. The upside from these bond funds is now limited, as is their offsetting protection against further stock losses. On the last day of the month we carried out a fairly extensive trade, largely to achieve two goals: to reduce our exposure to longer term bonds, and to shift more of our portfolio abroad — even to China.

You will no longer see them in the performance tables for the month, as we sold them at the end of the month, but the February returns were pretty high for our doom and gloom holdings that we sold: Vanguard Extended Duration Treasury (EDV) up 8.24%, Proshares Ultrashort Russel2000 (TWM) up 17.68%, and PowerShares DB Crude Oil Dble Short (DTO) up 25.61%. The losers of the month include Vanguard Utilities (VPU) down 9.99%, Vanguard Telecom Services ETF (VOX) down 5.63%, iShares MSCI Italy Capped (EWI) down 5.35%, Proshares Ultrashort NASDAQ Biotech (BIS) weirdly down 2.33%, as biotech had seemed like a solution to the outbreak, and Gold Short (DZZ) down 1.4%. These are not our exact returns as we sold these positions during the day on February 28.

This still leaves us with plenty of room to increase our stock allocation if this turns into a 2008 grade event with a 20—50% slide in stocks and a recession. The question remains: why would that be caused by a health event that to date has caused fewer deaths than die from cigarettes in China every day, and far fewer than the number of ordinary flu-related deaths per season? This is where we get into Black Swan territory — the unforeseen event that triggers major problems everywhere.

We are still at a point where all this could cease to be an issue, and the economic disruptions only create stock-buying opportunities — one more 'buy on the dip' moment. But the potential for Covid-19 to trigger something bigger is real. The main problem — which we have discussed before — is that our country is not positioned well to fight a sudden recession. We already have low interest rates, tax cuts, and government spending far in excess of tax revenue. We are in stimulus mode now. It is also not clear how more tax cuts and rate cuts would help.

On March 3 the Fed made an emergency interest rate cut of 0.50% and the market still tanked. It probably didn't help that the President said it was not enough, as so much of this is a matter of confidence. The issue this virus-related economic slowdown event creates is similar to how, when real estate prices started to decline, it exposed how risky real estate loans had become — there was no room for price declines.

Today there are many corporate borrowers who probably couldn't handle a major disruption to their business and still continue to make debt payments. This includes many commodity-related companies, such as popular master limited partnerships (MLPs) that transport energy products (which we used to short until the fund was liquidated for lack of interest). We could see a radical drop in energy consumption, beyond that experienced in the last recession. There are also companies that will be unable to obtain materials with which to make goods to sell. Much of the travel and leisure industry is facing lower volumes than in a recession, if this problem doesn't go away soon. Then there are the unknown liabilities that insurance companies may have; not so much in life insurance, but in business interruption insurance which may or may not include contagion coverage.

The best hope right now is that before businesses start missing debt payments, travel can resume, either because some sort of vaccine appears, or it turns out that the mortality rate for most people is low enough for it to seem flu-like. Until the risk of being quarantined or having your flights canceled is gone, there will be significant economic fallout globally. It would also be nice if we waived all the tariffs added against China and other countries in recent years, at least temporarily. Don't hold your breath.a.php?ticker=DZZ&pg=d">

Stock Funds1mo %
ISHARES MSCI BRIC ETF (BKF)-1.81%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.71%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-7.56%
VANGUARD FTSE DEVELOPED MARKET (VEA)-7.65%
VANGUARD FTSE EUROPE ETF (VGK)-7.96%
[Benchmark] Vanguard 500 Index (VFINX)-8.24%
HOMESTEAD VALUE FD (HOVLX)-9.38%
VANGUARD CRSP US LARGE CAP VAL (VTV)-9.71%
Bond Funds1mo %
VANGUARD LONG TERM BOND ETF (BLV)3.49%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.71%
VANGUARD MORTG-BACK SEC ETF (VMBS)0.89%
SPDR SERIES TRUST BLOMBERG INTL TR (BWX)0.03%
DODGE & COX FUNDS GLOBAL BOND (DODLX)-0.80%

Trade Alert

March 3, 2020

We made some changes to both our model portfolios on Friday 2/28/20. And while there where quite a few trades, the overall risk level from the stock bond mix hasn’t really changed significantly, more so we changed the types of stocks and bonds we wanted to be in going forward in light of some recent swings. As it turned out though, it’s a pity we didn’t increase the stock allocation much because as of Monday the stock market has been staging an amazing rebound (or dead cat bounce… only time will tell!). But then it’s typical that the highest point gain ever should come after the fastest 10% drop from a peak. Tuesday is showing markets back in the red as an emergency rate cut isn’t working. It’s that kind of a market now…

For the record, before and after this trade we are taking significantly less risk than the stock market. In February the Vanguard S&P 500 fund was down about 8.25% while our model portfolios where down about 3.1% for Aggressive and 1.8% for Conservative

As you probably noticed, stocks took a pounding and fell very fast and hard in the last week of February, largely because of growing fears that the Coronavirus outbreak will drag the global economy down significantly. This fear has also brought U.S. interest rates down to European levels, which we noted as a possible situation several times in the past and a reason to stay in longer term bonds at the time. 

In theory, a virus that still has caused fewer deaths globally than cigarettes cause every day in China shouldn’t have that much of a stock market impact. So even if there is a brief economic slowdown, it shouldn’t have much of an impact on earnings at companies over the next ten years, which is really the sort of timespan you should be looking at when you buy a stock. Much deferred spending today often just becomes future spending. It’s worth remembering that past similar viruses did not lead to major stock market events; even the 1918 Spanish flu, which killed perhaps as many as 50 million people globally, was almost a non-event as far as stocks were concerned or at least it’s impact was hard to separate from other economic issues at the time, like World War I. 

The reason this contagion may be different though is because today 1) stocks are expensive, and 2) we don’t have lots of room to fix economic problems. China now being a much bigger player in the global economy than it was during past health scares originating out of China is also a big factor to take into account.

We’ve discussed these issues of valuation and the lack of recession-busting options recently, but to sum it up: expensive stocks require good times ahead. This was the essence of the 2000 crash as the actual economy didn’t live up to the high prices of stocks at the time. 

Perhaps more troubling today, we’ve already got in place our tax cuts and low interest rates and government spending – the sort of mix that is typically used to give the economy a boost during a recession. Essentially, we’re deficit spending in a boom. So what are we going to do in the next recession? Go from a $1 trillion dollar deficit to a $3 trillion dollar deficit and cut rates to a negative 0.50%? 

There is also the issue of possible hidden problems lurking in the global economy that a sharp economic contraction will expose, even if briefly. Many people around the world today are not going about their ordinary business for fears of catching the virus. Much of this probably has more to do with the fear of being quarantined more than a worry about an actual mortality risk – because let’s face it, if you are young and healthy and can go to Italy for half off and with fewer tourists about that would be an appealing tradeoff for some, but not if there is the wild card of the risk of being quarantined for weeks in some makeshift camp. But now that flights are being cancelled for months into the future, even the virus brave are grounded.

There’s also likely to be a real drop in demand for commodities, like energy, and possibly a much sharper drop than in an ordinary recession and one that could leave heavy-in-debt energy-related companies scrambling to make debt payments. 

Ultimately the fear of a real 2008-style crash rests not just on high valuations but on rising debt defaults too, much like how falling home prices were the trigger to cascading defaults in what turned out to be a world of very shoddy real estate loans. And the concern is that some of these big corporate borrowers probably can’t handle a few months of sharply lower revenues. 

However, our trades here are not only because of the Coronacrash—several of these positions were already on the docket to be sold and we’ve noted the issues in past articles. The main reason was actually the sharp drop in rates related to the Coronacrash in stocks.

The benchmark 10-year government bond is now barely above 1%, down from around 3.16% in late 2018 before this long drop in rates started. We’ve now officially joined the European bond market, which should go hand in hand with low economic growth. While the relative value of stocks in such an environment is high, high priced stocks are not appealing in a slow growth economy. Nobody wants 50% downside just to upgrade from a 1% yield. Not in the short term at least.

More troubling to our portfolios is that we have relied on bond funds—notably long-term bond funds investing primarily in safe government debt—to lower the risk of our portfolios. Whenever stocks got rocky, we could almost bank on bonds doing well and vice versa. However, this relationship is nearing the end because ultimately we probably won’t go to negative interest rates in the U.S., simply because we borrow too much money for it to happen. If the Fed starts printing money to buy more bonds, it could happen, which is part of the problem in Europe.

The main thing we are doing here is cutting back on longer term bonds and shifting to investments abroad. We need some sort of bet to lower the risk of more stock losses and any foreign asset should do the trick, even though globally stocks have been going down as a group lately and in general they tend to move together. The reason is our dollar should slide as our rates ‘go European’ and our economy weakens. A 1,000 point drop in the Dow is going to hurt foreign stocks too, but over time if our dollar falls and valuations get closer there could be a major performance gap between here and abroad.

This could of course all represent an amazing buy-on-the-dip opportunity fueled by the temporarily low rates. But then being in long-term bonds only to see them slide sharply as rates go back to say 2% is not fun either. To be clear, we are taking on more default risk by adding say emerging market bonds and high-yield energy stocks and selling longer term U.S. debt, but hopefully this will not actually increase our downside significantly from here. If such a sharp slide continues, we may even trade again and increase our overall stock allocation. It is also entirely possible we could go in to recession mode with a 20%–40% slide and we’ll then be back to the high stock allocations we had in early 2009.

Aggressive Portfolio Trades

ISHARES JP MORGAN EM LOCAL CCY BD (LEMB)

New Bond Fund Holding – 12%

This one is risky as emerging market economies may have trouble with debt in a global crisis but the high yields and benefit of a falling U.S. dollar should help. The alternative is safer foreign bonds (like in our holding BWX, which we are reducing), but lower default risk foreign bonds typically yield nothing. 

VANGUARD SMALL-CAP VALUE ETF (VBR)

New Stock Fund Holding – 10%

After years of large cap growth outperformance, it is time for the market to swing back to favoring small cap value—an area we haven’t focused on here since the early 2000s. We used to own Vanguard Growth ETF—a large cap growth fund—and more recently had a small cap short position, which unfortunately wouldn’t work well for this purpose long haul, but the valuation call of preferring large cap growth years ago was right then. This fund is up only 4.52% annualized over the last 5 years compared to VUG Vanguard Growth, which is up 12.2% annualized. Now larger cap growth is overpriced, like in 1999, but with multiple trillion dollar large cap names, it is no wonder.

SPDR BLMBG BARCLAYS INTL TRS BD ETF (BWX)

Reduced Allocation Bond Fund – 20% to 10%

This fund actually has done well considering so many of the bonds have a negative yield. Basically, it is a play on the U.S. dollar falling and/or rates falling even more, but we’d rather achieve this in higher risk-and-return emerging market bonds given the recent drop in rates. 

VANGUARD ENERGY ETF (VDE)

New Stock Fund Holding – 8%

We’ve been anti-commodity for more than a decade and have been shorting them off and on for about that long. Owning commodities was popular a decade plus ago and has turned out a disaster for investors. While we likely won’t ever own commodities directly as they are never a good idea for investors, energy companies have gotten so cheap in this recent slide after a decade plus of bad performance, it should work out even if we just collect the 5%+ dividends—nothing to sneeze at in a 1% world. There is risk here as many smaller energy companies are leveraged and oil demand will likely tank with this virus threat (as noted in our other trade commentary), but companies like ExxonMobil which have raised dividends every year for almost four decades should be a safe bet, even if we actually get some dividend cuts. Many will simply borrow to pay the dividend at low rates. 

VANGUARD SHORT-TERM CORPORATE BOND (VCSH)

New Bond Fund Holding – 6%

This is not going to be a long-term holding and the yield is low today and also there is still some credit risk in a slowing economy. Another negative is the ongoing popularity of short-term bonds. We fully expect to sell this one for something else in the next year or so, but we’re trying to cut back on longer term bonds after the big run. 

FRANKLIN FTSE GERMANY ETF (FLGR)

New Stock Fund Holding – 6%

Germany is not growing fast and is facing a possible slowly dying manufacturing economy and has lost much ground to high-flying tech-focused America and low-cost China. That said, the yields are high and the valuations relatively low and the government is currently running a balanced budget and may consider—more than any other country—significant fiscal stimulus (actual spending) because, frankly, the negative interest rates aren’t doing much to help. The reality is, if we were running a balanced budget our own economy would be almost as sluggish. Franklin has very low-fee single-country ETFs, but the trading volume is so low they are not popular like the higher fee bigger alternatives from iShares. Hopefully, this lack of interest will change and these funds won’t get closed as is the risk with low-asset-level ETFs that are not profitable to manage.

FRANKLIN FTSE CHINA ETF (FLCH)

New Stock Fund Holding – 6%

This may be our biggest head scratcher. Why go into China now—ground zero of the virus and already hit by a trade war? However, while the short term can go poorly, China is still growing fast relative to other countries and its stock market has been in a decade-long doldrums coming off the stock bubble of the mid-2000s. There is also more potential for new government spending than in other major economies, like ours. Often the least popular move works out the best. Franklin has very low-fee single-country ETFs, but the trading volume is so low they are not popular like the higher fee alternatives, often from iShares. Hopefully, this lack of interest will change and these funds won’t get closed as is the risk with low-asset-level ETFs.

VANGUARD LONG-TERM BOND ETF (BLV)

Allocation Change – 20% to 6%

As noted, this fund is invested in long-term bonds and has benefited significantly from the slide in rates over the years, especially the drop that started in 2018. This fund is up 9% this year, 19% last year. The ten-year return is 8.25% annualized. That is stock-like with less risk, but now the risk is going up and the likely returns down. One reason long-term bonds have done so well is that so few owned them relative to shorter term bonds. Everybody was piled up in short-term bonds waiting for the big move up in rates that never happened. We fully expect to be able to go back to this fund or something similar when rates move up even to say 2% on the ten-year bond. In fact, we are still keeping an allocation here.

DIREXION DAILY JR GLD MNRS BEAR 3X (JDST)

New Inverse Fund Holding – 3%

This recent gold run-up will likely subside if we get more deflation from an economic slowdown or if the economy heats back up with low rates. There is also the situation that gold is still used in jewelry and that demand will drop in a global recession. The bull case is just more expectations of inflation that never come to being, but gold bugs don’t tend to care about bad long-term performance. We need to get out of DZZ—our gold bullion short—because the fund is too small and not well supported by the fund family (they won’t even return our calls!). This fund shorts with even more leverage than actual mining companies and could have real trouble in an economic slowdown, even if gold doesn’t fall sharply. 

PROSHARES ULTRAPRO SHORT QQQ (SQQQ)

New Inverse Fund Holding – 3%

We’re out of small cap shorting because the most overpriced part of the global market is larger cap tech stocks. That said, without a real market slide, this fund could down almost 100% over time, which is why it is only a very small allocation. If the market tanks, this fund will be sold and shifted to stocks for the eventual rebound. Frankly, it would be better to just short the actual QQQ ETF and even more frankly, if we could earn 3% again on longer term government bonds, we would just do that, but there are few good ways to reduce portfolio downside today.

PROSHARES ULTRAPRO 3X SHRT CRUDE OI (OILD)

New Inverse Fund Holding – 2%

Unlike almost all our other shorts, shorting commodities works even with these ill-conceived daily leveraged inverse funds. Our favorite was PIMCO CommoditiesPLUS Short Strategy Fund,  but PIMCO closed it on us right around when it would have become a great investment. Our longer term oil short (DTO) has almost always offered offsetting gains during stock weakness, partially because oil was often overpriced from speculation and the futures market typically priced oil more expensive in the future, giving the opportunity for a tailwind shorting. Adding to this, oil typically tanks in a recession when stocks sink. This new holding is more leveraged, unfortunately, but trades more frequently than the tiny DTO.

VANGUARD UTILITIES ETF (VPU)

Sold 7% to 0%

This fund delivered us nice low-risk returns, but utility stocks have been sucked into this obsession with low-volatility stocks and are now too popular, not because of the utility funds per se but because of the massive low-volatility ETFs. Many utility stocks are now no longer low volatility or low risk—just look at the price swings in recent days. The yields were nice in a falling rate environment, but at the end of the day these are now expensive slow-growth stocks, that may actually take an earnings hit if power demand drops in a recession or, worse, a virus outbreak. 

ISHARES MSCI ITALY CAPPED ETF (EWI)

Sold 6% to 0%

Italy just isn’t as out of favor as it was when we invested in this fund and is not the country to invest in during a slowing global economy—they just don’t have the money to do stimulus, though they are benefiting from the ultralow rates in Europe.

PROSHARES ULTRASHORT RUSSELL2000 (TWM)

Sold 3% to 0%

Several years ago small cap value stocks were overpriced compared to larger cap growth stocks, which were cheap after underperforming in the 2000s. Unfortunately, there were no small cap value inverse funds, just small caps and in general these funds don’t offer any long-term value, but they can reduce downside in a slide. Ultimately, investors are better off just avoiding overpriced areas, not shorting. Not going to sugarcoat it… these funds have hurt us. We should have just owned even more long-term bonds.

Vanguard Communication Services ETF (VOX)

Sold 3% to 0%

This fund became a mess right around when it morphed into a tech fund, which we noted and used as a reason to sell it in our other lower risk portfolio. It was a loser even with Google and Facebook stakes and is now a risky fund for a market crash, unlike before, which is why it needs to go.

PROSHARES ULTRASHORT NASDAQ BIOTECH (BIS)

Sold 3% to 0%

Biotech stocks are still overpriced, even though they have slightly underperformed the S&P 500 with more risk. That said, this inverse fund won’t help in the long run or the short term as biotech may seem appealing to investors during coronavirus-type outbreaks. 

DB CRUDE OIL DOUBLE SHORT ETN (DTO)

Sold 3% to 0%

The fact that this leveraged short fund has had a positive return since it launched in 2008 is amazing given the almost-certain negative returns of any leveraged inverse fund over time. The fact that it tends to skyrocket in price when stocks fall is another plus (it was recently up over 40% YTD). That said, the wind at its back has been generally higher oil prices in the future than the current (spot) market, making shorting futures slightly profitable with no change in the oil price. This phenomenon isn’t as good as it has been, but in truth, the main reasons we are trading this fund for another oil short are illiquidity and fund size.  

DB GOLD DOUBLE SHORT ETN (DZZ)

Sold 6% to 0%

Gold and silver are still bad investments, although for some reason millions of people haven’t noticed despite the prices still being below the levels they hit in 2011 (significantly below in silver’s case) while stocks have more than doubled. You still see gold coin ads everywhere (often sham collectable coins). That said, this fund doesn’t trade enough to use and is basically not supported by the fund family (they won’t call us back!), so we are switching to a more actively traded short on gold-mining stocks.

Conservative Portfolio Trades

VANGUARD SHORT-TERM BOND ETF (BSV)

New Bond Fund Holding – 15%

This is probably not going to be a long-term holding, the yield is low, and there is still some credit risk in a slowing economy (though less than our new corporate short-term fund). Another negative is the ongoing popularity of short-term bonds. We fully expect to sell this holding for something else in the next year or so but we’re trying to cut back on longer term bonds after the big run. 

VANGUARD FTSE EUROPE ETF (VGK)

Allocation Change – 8% to 12%

Europe is cheaper than the U.S. now and when you adjust for our deficit spending boosting our GDP, it’s not growing that much slower. There is more room for fiscal stimulus, especially in Germany. They also don’t have the worry of increasing socialism—they already have it! The dividend yield is higher and there could be a return boost if our dollar sinks, which might happen after years of riding high.

VANGUARD ENERGY ETF (VDE)

New Stock Fund Holding – 10%

FRANKLIN FTSE GERMANY ETF (FLGR)

New Stock Fund Holding – 7%

ISHARES JP MORGAN EM LOCAL CCY BD (LEMB)

New Bond Fund Holding – 7%

VANGUARD LONG-TERM BOND ETF (BLV)

Allocation Change – 19% to 6%

VANGUARD MORTGAGE-BACKED SECS ETF (VMBS)

Allocation Change – 12% to 6%

In theory, we could hang on to this fund as mortgages haven’t declined in perfect lockstep with treasury bond rates, but at the same time, they are still not offering much yield as well as little benefit from further rate cuts. The expected return is so low from here though that we’d rather add a little risk and reward, plus we just added a short-term bond fund which doesn’t yield that much less.

VANGUARD UTILITIES ETF (VPU)

Sold – 6% to 0%

ISHARES TRUST GLOBAL COMM SERVICES ETF (IXP)

Sold – 13% to 0%

Shortly after (VOX) became essentially a tech fund, this ETF did the same. It was mediocre even with Google and Facebook stakes and is now a risky fund for a market crash, unlike before when it was more of a telecom utility fund, which is why it needs to go now.

VANGUARD EXTENDED DUR ETF (EDV)

Sold – 5% to 0%

This fund has been a long-time staple here and remains underowned (though much larger than when we bought it). This low-fee fund owns zero coupon bonds, which are essentially default-risk free, but with the most interest rate risk possible in the bond world, even slight changes in long-term rates can lead to wild swings in this fund. This fund is actually slightly more volatile than the S&P 500. However, it tends to take off when stocks fall and has been a great hedge against stock market risk—better over time than any shorting strategy. The fund was up over 18% last year and so far in 2020. The ten-year return is 11.65%, compared to 12.90% for the S&P 500 ETF (SPY). That said, with a 1% ten-year government bond, the downside is higher than the upside by far, even though interest rates will probably not break 3% on the ten year for years to come. We will be back in this fund if rates climb significantly. It is possible this fund will do another 20%+ as rates go closer to zero, but 90%+ of the money has already been made here. At the end of the day, bonds are not stocks and this fund can’t match the S&P 500 over the next 10 years, unless the stock market is about where it is now in a decade.