The sharp rebound in stocks in early 2019 ended just as rapidly in May, with a 6.36% drop in the Vanguard 500 index fund including dividends. In late April, just days after the U.S. stock market broke through the old highs from September 2018 and gained back all the losses from late last year, stocks started falling. At one point in early June, the Nasdaq was back down around 10% from the recent highs—a percentage drop considered a correction (a bear market is 20%).
Last month's stock market weakness was pretty much across the globe, with no area showing positive returns. Bonds, however, continued to do well as interest rates plunged to the lowest levels since 2017. This interest rate action helped our portfolios fall much less than the market or the Vanguard balanced fund we use as a portfolio benchmark.
What makes this behavior interesting is how it related to interest rates. Last year, the stock slide started because interest rates were going up somewhat sharply. The Federal Reserve was raising shorter-term rates and longer-term rates were creeping up as well. Then panic set in that rising rates might cause another recession, as the global economy seemed to be wobbling and trade war fears seemed menacing. After a few weeks of dropping late last year, the stock market was down around 20% from earlier highs or the level that is considered a bear market. The Federal Reserve calmed everyone down and noted they will not keep raising rates, but by then falling longer-term rates had already started declining.
After the holidays, the stock market turned around and the global economy looked a little better. Investors regained confidence that with lower rates and resulting lower mortgage rates, the economy should stay strong. Good jobs and GDP numbers this year helped with this narrative. Then a funny/not funny thing happened: rates kept going down, actually plunging in recent days, at one point down to around just 2.08% on the 10-year government bond. This equates to a sub 4% thirty-year mortgage. Rates were more than one full percentage point higher last November, at just over 3.2% for comparison. The fear now in stocks is that surely a recession is coming or why would interest rates be so low? Unlike past bouts of low rates, short-term rates are not about as high as longer-term rates, thanks to the Fed raising rates. This sort of spread further scares investors that we are heading into recession.
Where we go from here is either we're going to get a recession in the next year or so and the market will probably fall another 20% or more early in that trajectory of economic slowdown, or we start getting even hotter economic numbers boosted from the now lower interest rates, and then rates will climb back up with stocks and maybe inflation, hurting bonds.
With all that interest rate action trying to forecast our economic future, we have a parallel problem on the growth side of the stock market in technology. Some recent troubles at Tesla, Uber, and the like seem to point to no end in profitless growth for some hot tech names, while the hot tech names that actually mint money, like Google, Apple, and Facebook may be near the end of high margins and growth resulting more and more from their monopoly status.
The trouble going forward is we are losing our upside potential from our long-term bonds the lower rates go, though it is worth noting that rates are much lower in other major economies. At some point we're either going to have to move to stocks or short-term bonds. The trouble with short-term bonds is that although you are protected somewhat from rates going back up, you are not protected from rates going down even more. In all likelihood the Federal Reserve is going to be lowering rates later this year if the economy trips. This is going to send a 2% yield on shorter-term bond funds down towards 1% again. It might make more sense to just keep the longer-term bonds and slightly increase stocks, so you have more offsetting gains should rates go back up, hurting longer-term bonds.
Looking at fund investor behavior over the last six months of this wild stock and bond market has shown what not to do. First, back in October, investors started pulling money out of bond funds right as rates peaked and after some weak returns in bond funds, and bonds started to do well again. Then fund investors started taking money out of stocks more aggressively in December (with near $60 billion out that month alone) and January around the bottom in stocks. The money hasn't come back in much in stocks during the recovery earlier this year, but, broadly speaking, between bonds and stocks, stocks are less in favor with fund flows and probably are the better choice going forward if you can stomach the risk of being in stocks going into a recession.
Apparently the slide scared the Federal Reserve because on June 4th the market turned back up sharply on the near guarantee of lower rates and easy monetary policy from the Fed.
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The sharp rebound in stocks in early 2019 ended just as rapidly in May, with a 6.36% drop in the Vanguard 500 index fund including dividends. In late April, just days after the U.S. stock market broke through the old highs from September 2018 and gained back all the losses from late last year, stocks started falling. At one point in early June, the Nasdaq was back down around 10% from the recent highs—a percentage drop considered a correction (a bear market is 20%).
Last month's stock market weakness was pretty much across the globe, with no area showing positive returns. Bonds, however, continued to do well as interest rates plunged to the lowest levels since 2017. This interest rate action helped our portfolios fall much less than the market or the Vanguard balanced fund we use as a portfolio benchmark.
Our Conservative portfolio declined 0.50%. Our Aggressive portfolio declined 1.82%. Benchmark Vanguard funds for May 2019 were as follows: Vanguard 500 Index Fund (VFINX), down 6.36%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.83%; Vanguard Developed Markets Index Fund (VTMGX), down 5.26%; Vanguard Emerging Markets Stock Index (VEIEX), down 6.45%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.90%.
What makes this behavior interesting is how it related to interest rates. Last year, the stock slide started because interest rates were going up somewhat sharply. The Federal Reserve was raising shorter-term rates and longer-term rates were creeping up as well. Then panic set in that rising rates might cause another recession, as the global economy seemed to be wobbling and trade war fears seemed menacing. After a few weeks of dropping late last year, the stock market was down around 20% from earlier highs or the level that is considered a bear market. The Federal Reserve calmed everyone down and noted they will not keep raising rates, but by then falling longer-term rates had already started declining.
After the holidays, the stock market turned around and the global economy looked a little better. Investors regained confidence that with lower rates and resulting lower mortgage rates, the economy should stay strong. Good jobs and GDP numbers this year helped with this narrative. Then a funny/not funny thing happened: rates kept going down, actually plunging in recent days, at one point down to around just 2.08% on the 10-year government bond. This equates to a sub 4% thirty-year mortgage. Rates were more than one full percentage point higher last November, at just over 3.2% for comparison. The fear now in stocks is that surely a recession is coming or why would interest rates be so low? Unlike past bouts of low rates, short-term rates are not about as high as longer-term rates, thanks to the Fed raising rates. This sort of spread further scares investors that we are heading into recession.
Where we go from here is either we're going to get a recession in the next year or so and the market will probably fall another 20% or more early in that trajectory of economic slowdown, or we start getting even hotter economic numbers boosted from the now lower interest rates, and then rates will climb back up with stocks and maybe inflation, hurting bonds.
With all that interest rate action trying to forecast our economic future, we have a parallel problem on the growth side of the stock market in technology. Some recent troubles at Tesla, Uber, and the like seem to point to no end in profitless growth for some hot tech names, while the hot tech names that actually mint money, like Google, Apple, and Facebook may be near the end of high margins and growth resulting more and more from their monopoly status.
In our portfolios, our own losses in stock funds were largely offset by gains in our short funds (except gold), which were all up double digits, and big gains in longer-term bonds with Vanguard Extended Duration Treasury (EDV) up 9.74% and Vanguard Long-Term Bond Index ETF (BLV) up 4.16%. Higher-risk bonds moved down with stocks, which is why Dodge & Cox Global Bond Fund (DODLX) was down 0.46%—our only negative bond fund last month.
The trouble going forward is we are losing our upside potential from our long-term bonds the lower rates go, though it is worth noting that rates are much lower in other major economies. At some point we're either going to have to move to stocks or short-term bonds. The trouble with short-term bonds is that although you are protected somewhat from rates going back up, you are not protected from rates going down even more. In all likelihood the Federal Reserve is going to be lowering rates later this year if the economy trips. This is going to send a 2% yield on shorter-term bond funds down towards 1% again. It might make more sense to just keep the longer-term bonds and slightly increase stocks, so you have more offsetting gains should rates go back up, hurting longer-term bonds.
Looking at fund investor behavior over the last six months of this wild stock and bond market has shown what not to do. First, back in October, investors started pulling money out of bond funds right as rates peaked and after some weak returns in bond funds, and bonds started to do well again. Then fund investors started taking money out of stocks more aggressively in December (with near $60 billion out that month alone) and January around the bottom in stocks. The money hasn't come back in much in stocks during the recovery earlier this year, but, broadly speaking, between bonds and stocks, stocks are less in favor with fund flows and probably are the better choice going forward if you can stomach the risk of being in stocks going into a recession.
Apparently the slide scared the Federal Reserve because on June 4th the market turned back up sharply on the near guarantee of lower rates and easy monetary policy from the Fed.