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.
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.
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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.