The market continued to recover quickly from the slide late last year. This year, the leaders are mostly the areas that fell the hardest during the mini-bear market of 2018. With foreign markets, value stocks, and lower credit risk bonds weak in February and our relatively low allocation to the hotter areas of the market (like tech and small cap), our model portfolios lagged the U.S. market.
Our best performers were Homestead Value (HOVLX) and Vanguard Utilities (VPU), with 4.73% and 3.88% returns in February. This was a relatively weak month for value- and dividend-oriented stocks, so these were, to a certain extent, outliers. Telecom stocks were weak globally, with Vanguard Telecom Services ETF (VOX) and iShares Global Telecom ETF (IXP) barely up at all. Other than a 1.63% return shorting gold with Gold Short (DZZ), our weakest areas, as you would imagine, were short funds as global stocks and oil rose.
In bonds, all our funds fell except for a relatively new holding Dodge & Cox Global Bond Fund (DODLX), which is actively managed (not an index fund) and takes a little more credit risk than our other holdings that were held down by slightly rising interest rates.
The hottest areas last month included U.S. small-cap growth funds, up just over 6% in February, almost double the S&P 500. Stocks in China were hot, as their economy and stock market probably have more to gain if this trade war winds down because they have seen more of a drag to both.
Emerging markets in general performed about as well as the U.S. market last month. Investors were comfortable with risk again as higher credit risk bonds did well, even as safer, longer-term bonds were down. Technology stocks continued a sharp rebound, though energy stocks didn't rise with oil prices.
Much of this rebound is driven by relief that the Federal Reserve is no longer on inflation watch, risking causing our next recession to fight it. In addition to not raising shorter term rates more, the Federal Reserve is likely going to slow—if not stop—the already slow unwinding of the so-called "balance sheet".
In brief, this is the roughly $4 trillion in new money the Fed created during the financial meltdown and its aftermath to counter the money destruction and deflationary forces in a crashing economy. The Fed essentially created money out of thin air, bought bonds mostly from the U.S. Government, then sat on those bonds, collecting interest. This put new money into the system and lowered longer-term interest rates including, importantly, mortgage rates. They called this process "Quantitative Easing", or QE, rather than "New Money Maker" or something that might frighten investors.
The unwinding means the Fed essentially burns the interest payments they were receiving monthly—to the tune of around $55 billion a month—in a digital furnace. This is the opposite of what they were doing when they created money in the crash aftermath years. Investors started getting scared this printing press in reverse was going to cause a recession, so the Fed is now considering collecting the interest payments and just buying more debt with them (as opposed to destroying the payments and making the money pool shrink). This means in the next recession we'll probably just start creating even more money out of thin air to buy bonds again because, even in a good economy, we can barely destroy some of the new money created in the last recession without a mini-meltdown.
While this all seems quite scary, it is still one step away from actually creating money to buy government debt and then saying "Forget it. You don't owe us anything, U.S. Government. Keep the new money." That is called monetizing the debt and, officially, we are not there yet. Even monetizing the debt is still a step away from just printing money and paying bills, like they apparently have been doing in Venezuela.
The important distinction between us and Venezuela is we can still reverse engines if inflation picks up. In fact, we have more power to stop inflation than perhaps at any time in history because we can just sell our $4 trillion in bonds and destroy the proceeds. Imagine selling a bond you own, getting cash out from the bank, and burning it in the backyard—that money is gone from the system. You are shrinking the money supply and doing the opposite of leaving that money in the bank, where it would become available to make new loans.
But the danger here is not inflation, even though it seems the obvious risk attached to creating money to fix problems. The danger is deflation and recessions that can't be fixed, even by unorthodox monetary policy. Since our government is now growing the yearly deficit again significantly—just recently, we started moving close to a gap of $1 trillion a year between what we collect in tax revenues and what we spend—our ability to fight the next recession with more tax cuts and interest rate cuts is diminishing. Nobody wants to shore up the budget, and investors freak out when interest rates go up. We're trapped.
This situation could increase the severity of our next recession and the next bear market
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The market continued to recover quickly from the slide late last year. This year, the leaders are mostly the areas that fell the hardest during the mini-bear market of 2018. With foreign markets, value stocks, and lower credit risk bonds weak in February and our relatively low allocation to the hotter areas of the market (like tech and small cap), our model portfolios lagged the U.S. market.
Our Conservative portfolio gained 0.93%. Our Aggressive portfolio gained 0.73%. Benchmark Vanguard funds for February 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 3.20%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.06%; Vanguard Developed Markets Index Fund (VTMGX), up 2.18%; Vanguard Emerging Markets Stock Index (VEIEX), up 0.65%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.31%.
Our best performers were Homestead Value (HOVLX) and Vanguard Utilities (VPU), with 4.73% and 3.88% returns in February. This was a relatively weak month for value- and dividend-oriented stocks, so these were, to a certain extent, outliers. Telecom stocks were weak globally, with Vanguard Telecom Services ETF (VOX) and iShares Global Telecom ETF (IXP) barely up at all. Other than a 1.63% return shorting gold with Gold Short (DZZ), our weakest areas, as you would imagine, were short funds as global stocks and oil rose.
In bonds, all our funds fell except for a relatively new holding Dodge & Cox Global Bond Fund (DODLX), which is actively managed (not an index fund) and takes a little more credit risk than our other holdings that were held down by slightly rising interest rates.
The hottest areas last month included U.S. small-cap growth funds, up just over 6% in February, almost double the S&P 500. Stocks in China were hot, as their economy and stock market probably have more to gain if this trade war winds down because they have seen more of a drag to both.
Emerging markets in general performed about as well as the U.S. market last month. Investors were comfortable with risk again as higher credit risk bonds did well, even as safer, longer-term bonds were down. Technology stocks continued a sharp rebound, though energy stocks didn't rise with oil prices.
Much of this rebound is driven by relief that the Federal Reserve is no longer on inflation watch, risking causing our next recession to fight it. In addition to not raising shorter term rates more, the Federal Reserve is likely going to slow—if not stop—the already slow unwinding of the so-called "balance sheet".
In brief, this is the roughly $4 trillion in new money the Fed created during the financial meltdown and its aftermath to counter the money destruction and deflationary forces in a crashing economy. The Fed essentially created money out of thin air, bought bonds mostly from the U.S. Government, then sat on those bonds, collecting interest. This put new money into the system and lowered longer-term interest rates including, importantly, mortgage rates. They called this process "Quantitative Easing", or QE, rather than "New Money Maker" or something that might frighten investors.
The unwinding means the Fed essentially burns the interest payments they were receiving monthly—to the tune of around $55 billion a month—in a digital furnace. This is the opposite of what they were doing when they created money in the crash aftermath years. Investors started getting scared this printing press in reverse was going to cause a recession, so the Fed is now considering collecting the interest payments and just buying more debt with them (as opposed to destroying the payments and making the money pool shrink). This means in the next recession we'll probably just start creating even more money out of thin air to buy bonds again because, even in a good economy, we can barely destroy some of the new money created in the last recession without a mini-meltdown.
While this all seems quite scary, it is still one step away from actually creating money to buy government debt and then saying "Forget it. You don't owe us anything, U.S. Government. Keep the new money." That is called monetizing the debt and, officially, we are not there yet. Even monetizing the debt is still a step away from just printing money and paying bills, like they apparently have been doing in Venezuela.
The important distinction between us and Venezuela is we can still reverse engines if inflation picks up. In fact, we have more power to stop inflation than perhaps at any time in history because we can just sell our $4 trillion in bonds and destroy the proceeds. Imagine selling a bond you own, getting cash out from the bank, and burning it in the backyard—that money is gone from the system. You are shrinking the money supply and doing the opposite of leaving that money in the bank, where it would become available to make new loans.
But the danger here is not inflation, even though it seems the obvious risk attached to creating money to fix problems. The danger is deflation and recessions that can't be fixed, even by unorthodox monetary policy. Since our government is now growing the yearly deficit again significantly—just recently, we started moving close to a gap of $1 trillion a year between what we collect in tax revenues and what we spend—our ability to fight the next recession with more tax cuts and interest rate cuts is diminishing. Nobody wants to shore up the budget, and investors freak out when interest rates go up. We're trapped.
This situation could increase the severity of our next recession and the next bear market