If ever there was a year for American exceptionalism, it was 2021. Our vaccines, if not our deployment, were at the top of the global heap (with some help from Germany). Our stock market as measured by the S&P 500 delivered a remarkable 28%+ return for the year, while the main foreign developed markets index was up around 8%.
For the year, we were up 10.85% in our Conservative portfolio, and 11.35% in our Aggressive portfolio — solid, except when you look at the US stock market, and then it was a miss, even adjusting for the 1.86% negative return in the total bond index fund for 2021. The slightly riskier Vanguard Balanced Index (VBINX) was up 14.09% in 2021, to get an idea where a 60/40 stocks to bonds with no foreign stocks portfolio did last year. And yes, we're in the sort of overheated market where you have to apologize for double-digit returns not measuring up…
This was one of the few years recently that we beat Vanguard Star Fund (VGSTX), a global balanced fund. At around 63% stocks (and about two thirds of that US stocks), it is a little riskier than our portfolios these days but is the main benchmark we try to beat. When the market is down, like in 2018, we fell by less. This fund was up 9.65% in 2021.
We beat this top low-cost global fund partially because we had some areas that outperformed the S&P 500 in 2021, like our recently sold Vanguard Energy (VDE) and Vanguard Small-Cap Value (VBR), and our bond picks were inflation adjusted and had gains while the overall bond market was down. We also rebalanced out of some hot areas like Franklin FTSE South Korea (FLKR) early in the year, booking some gains in areas that weakened as the year progressed.
In December some of our holdings took off, boosting our relative return, notably Vanguard Utilities (VPU) which was up a whopping (for utilities stocks) 9.42% for the month right after we increased the allocation from 5% to 10%. VanEck Vectors Pharma. (PPH) was up 7.74% in what seems to be a move out of trendy, no-earnings stocks to safe, higher-dividend, older stocks.
Current holdings that did well in 2021 were Homestead Value Fund (HOVLX) and Vanguard Value Index (VTV), both value funds up just shy of the S&P 500 with 25% and 28.6% returns, respectively. The only fund categories to beat the S&P 500 in 2021 were energy (#1) and other natural resources, real estate, small cap value, and financials. Our recently sold Vanguard Energy (VDE) holding was up 56% for the year. Losers in 2021 were most emerging markets; notably, Latin America and China. Our own holdings Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) were down 17.12% and 20.81% for the year, with a basically flat year for emerging markets.
Foreign stocks — notably China, the # 2 largest economy — started to sink after the big rebound off the Covid-crash lows while US stocks remained on the up and up. Much of this was currency fluctuations, but in general, foreign stocks have wildly underperformed US markets even looking at currency-hedged funds; notably, emerging markets.
When you buy a total global stock index fund today, you get 60% US stocks. You won't see a foreign name in the top 10 anymore. Toyota (TM) — Japan's biggest company by market value and the world's number one car company by earnings — is just 0.28% of the fund. You'll get almost 5x as much Tesla (TSLA) investing in the fund.
To Tesla stock fans, this matters as much as noting Nokia was once the top cell phone company and Apple was overpriced at the dawn of the iPhone. I'd reply to that by noting that Apple wasn't worth over a trillion dollars at the dawn of the iPhone as Tesla is today; it was worth $100 billion.
The future now costs 10x as much.
Back before this long run of foreign stock underperformance, half the global top 10 was foreign, mostly companies in China. In 1999, before the big run in foreign stocks, it was 80% US stocks.
US GDP is just 25% of global GDP. This doesn't mean the US should be at 25% of global market cap for many reasons; notably, more of our economy is publicly traded, and the tech monopolies are located here. But as recently as 2007, after a few years of foreign stocks outperforming the US (much because our dollar sank in value), our stocks were down to around 30% of global market cap. We are double that now.
We are at, or near, the high of our stock market valuation relative to foreign markets.
Historically, US vs foreign stocks go through periods of performance gaps, much of it currency related, and as a sort of reversion to the mean we're probably due for a few years of underperformance relative to foreign stocks. But then, we were due for this at the beginning of this year and yet… here we are with another year of US dominance of global stock markets. Note that we can get back to normal levels by just falling more than foreign stocks in the next bear market.
It is hard to escape the feeling we are in a new grand bubble that has lifted most assets, including essentially all US stocks, bonds, and real estate. Unlike in past slides, there may be no safe resting place for (the money of) the wicked.
To get an idea how bad things could get, imagine if we returned to the valuations of the bottom of the 2007—09 crash, perhaps the last time stocks were cheap since the early 1990s.
To use the so-called Buffett Indicator, which is the ratio of total stock market value to our GDP, we got down to 50% of stock market value to GDP in early 2009 (from a then bubble high of around 150% in early 2000).
Today, stocks are worth $53 trillion, and our current GDP probably hit around $24 trillion by the end of 2021 (largely "thanks" to inflation), or 220% of GDP. If we had a crash back to 50% of GDP or $12 trillion it would be a — gulp — roughly 80% fall.
There are many things different today that could "stop" such a calamity; notably, low rates and a central bank willing to create money and buy assets well before we get to such levels. Frankly, we don't do Great Depressions anymore — the government steps in to make the bets whole again.
One unfortunate side effect is everybody who's anybody knows the support is there and is willing to pay a higher price for assets because the downside seems limited. All this does is create the need for greater support the next time around. It is unclear what will fix housing the next time it crashes — 0% mortgages?
Perhaps the end game is inflation, currently running near double-digit levels in the longest period of "transitory" in history.
Inflation can support inflated asset prices by inflating the fundamentals: rents, earnings, etc. Even the non-inflation-adjusted GDP can inflate, as it has this year. Inflation will also do wonders for our deeply indebted government now committed to running deficits in good times and bad, assuming rates stay below inflation, and why wouldn't they if the Fed creates money to buy bonds and push yields down?
The trouble with this inflationary soft landing is it requires — to quote now infamous 1920s economist Irving Fisher — a permanently high plateau in stocks. We have to freeze prices here and let the fundamentals inflate. But that won't happen. We'll turn 10% inflation into a reason to pay 30% more for homes and stocks as the only game in town to protect you from the inflation.
Our American exceptionalism is hiding questionable longer-term fundamentals. We're in an asset bubble where everything collectible has unlimited upside and little downside. We can't get the economy growing faster than other slow-growth economies globally without permanent fiscal and monetary stimulus. We could never balance the budget without causing a depression, much less reduce the trillions the central bank created to support the economy by removing money from the system without causing deflation and asset price collapse.
There is always the chance we get another near 30% year because bubbles can always get bigger. It is possible we inflate our way out of this one at great long-term cost to safety-seeking investors in cash and lower risk bonds. This risk is the main reason we're not 80% cash and bonds now. We can't safely earn 5% in a 3% inflation world; we can only safely earn 1% in a 7% inflation world.
There are already signs this grand bubble era is ending. Trendy stocks trading on stories without earnings are already crashing — most are now in a bear market. Formerly hot funds like ARK Innovation ETF (ARKK) were down 23% last year, while the rest of the stock market went to the moon.
The real question for 2022 is whether this bear market in hype eventually drags the whole economy and market down, sort of like the dot com crash of 2000. Can the economy handle losing trillions in paper value in digital collectibles?
Or has the stock market become a metaverse, and it no longer matters what assets were valued at in the real world of the past?
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If ever there was a year for American exceptionalism, it was 2021. Our vaccines, if not our deployment, were at the top of the global heap (with some help from Germany). Our stock market as measured by the S&P 500 delivered a remarkable 28%+ return for the year, while the main foreign developed markets index was up around 8%.
For the year, we were up 10.85% in our Conservative portfolio, and 11.35% in our Aggressive portfolio — solid, except when you look at the US stock market, and then it was a miss, even adjusting for the 1.86% negative return in the total bond index fund for 2021. The slightly riskier Vanguard Balanced Index (VBINX) was up 14.09% in 2021, to get an idea where a 60/40 stocks to bonds with no foreign stocks portfolio did last year. And yes, we're in the sort of overheated market where you have to apologize for double-digit returns not measuring up…
For the last month of the year, our Conservative portfolio gained 2.29% , and our Aggressive portfolio gained 2.97%. Benchmark Vanguard funds for December 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 4.48%; Vanguard Total Bond Index (VBMFX), down 0.41%; Vanguard Developed Mkts Index (VTMGX), up 4.80%; Vanguard Emerging Mkts Index (VEIEX), up 1.74%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.37%.
This was one of the few years recently that we beat Vanguard Star Fund (VGSTX), a global balanced fund. At around 63% stocks (and about two thirds of that US stocks), it is a little riskier than our portfolios these days but is the main benchmark we try to beat. When the market is down, like in 2018, we fell by less. This fund was up 9.65% in 2021.
We beat this top low-cost global fund partially because we had some areas that outperformed the S&P 500 in 2021, like our recently sold Vanguard Energy (VDE) and Vanguard Small-Cap Value (VBR), and our bond picks were inflation adjusted and had gains while the overall bond market was down. We also rebalanced out of some hot areas like Franklin FTSE South Korea (FLKR) early in the year, booking some gains in areas that weakened as the year progressed.
In December some of our holdings took off, boosting our relative return, notably Vanguard Utilities (VPU) which was up a whopping (for utilities stocks) 9.42% for the month right after we increased the allocation from 5% to 10%. VanEck Vectors Pharma. (PPH) was up 7.74% in what seems to be a move out of trendy, no-earnings stocks to safe, higher-dividend, older stocks.
Current holdings that did well in 2021 were Homestead Value Fund (HOVLX) and Vanguard Value Index (VTV), both value funds up just shy of the S&P 500 with 25% and 28.6% returns, respectively. The only fund categories to beat the S&P 500 in 2021 were energy (#1) and other natural resources, real estate, small cap value, and financials. Our recently sold Vanguard Energy (VDE) holding was up 56% for the year. Losers in 2021 were most emerging markets; notably, Latin America and China. Our own holdings Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) were down 17.12% and 20.81% for the year, with a basically flat year for emerging markets.
Foreign stocks — notably China, the # 2 largest economy — started to sink after the big rebound off the Covid-crash lows while US stocks remained on the up and up. Much of this was currency fluctuations, but in general, foreign stocks have wildly underperformed US markets even looking at currency-hedged funds; notably, emerging markets.
When you buy a total global stock index fund today, you get 60% US stocks. You won't see a foreign name in the top 10 anymore. Toyota (TM) — Japan's biggest company by market value and the world's number one car company by earnings — is just 0.28% of the fund. You'll get almost 5x as much Tesla (TSLA) investing in the fund.
To Tesla stock fans, this matters as much as noting Nokia was once the top cell phone company and Apple was overpriced at the dawn of the iPhone. I'd reply to that by noting that Apple wasn't worth over a trillion dollars at the dawn of the iPhone as Tesla is today; it was worth $100 billion.
The future now costs 10x as much.
Back before this long run of foreign stock underperformance, half the global top 10 was foreign, mostly companies in China. In 1999, before the big run in foreign stocks, it was 80% US stocks.
US GDP is just 25% of global GDP. This doesn't mean the US should be at 25% of global market cap for many reasons; notably, more of our economy is publicly traded, and the tech monopolies are located here. But as recently as 2007, after a few years of foreign stocks outperforming the US (much because our dollar sank in value), our stocks were down to around 30% of global market cap. We are double that now.
We are at, or near, the high of our stock market valuation relative to foreign markets.
Historically, US vs foreign stocks go through periods of performance gaps, much of it currency related, and as a sort of reversion to the mean we're probably due for a few years of underperformance relative to foreign stocks. But then, we were due for this at the beginning of this year and yet… here we are with another year of US dominance of global stock markets. Note that we can get back to normal levels by just falling more than foreign stocks in the next bear market.
It is hard to escape the feeling we are in a new grand bubble that has lifted most assets, including essentially all US stocks, bonds, and real estate. Unlike in past slides, there may be no safe resting place for (the money of) the wicked.
To get an idea how bad things could get, imagine if we returned to the valuations of the bottom of the 2007—09 crash, perhaps the last time stocks were cheap since the early 1990s.
To use the so-called Buffett Indicator, which is the ratio of total stock market value to our GDP, we got down to 50% of stock market value to GDP in early 2009 (from a then bubble high of around 150% in early 2000).
Today, stocks are worth $53 trillion, and our current GDP probably hit around $24 trillion by the end of 2021 (largely "thanks" to inflation), or 220% of GDP. If we had a crash back to 50% of GDP or $12 trillion it would be a — gulp — roughly 80% fall.
There are many things different today that could "stop" such a calamity; notably, low rates and a central bank willing to create money and buy assets well before we get to such levels. Frankly, we don't do Great Depressions anymore — the government steps in to make the bets whole again.
One unfortunate side effect is everybody who's anybody knows the support is there and is willing to pay a higher price for assets because the downside seems limited. All this does is create the need for greater support the next time around. It is unclear what will fix housing the next time it crashes — 0% mortgages?
Perhaps the end game is inflation, currently running near double-digit levels in the longest period of "transitory" in history.
Inflation can support inflated asset prices by inflating the fundamentals: rents, earnings, etc. Even the non-inflation-adjusted GDP can inflate, as it has this year. Inflation will also do wonders for our deeply indebted government now committed to running deficits in good times and bad, assuming rates stay below inflation, and why wouldn't they if the Fed creates money to buy bonds and push yields down?
The trouble with this inflationary soft landing is it requires — to quote now infamous 1920s economist Irving Fisher — a permanently high plateau in stocks. We have to freeze prices here and let the fundamentals inflate. But that won't happen. We'll turn 10% inflation into a reason to pay 30% more for homes and stocks as the only game in town to protect you from the inflation.
Our American exceptionalism is hiding questionable longer-term fundamentals. We're in an asset bubble where everything collectible has unlimited upside and little downside. We can't get the economy growing faster than other slow-growth economies globally without permanent fiscal and monetary stimulus. We could never balance the budget without causing a depression, much less reduce the trillions the central bank created to support the economy by removing money from the system without causing deflation and asset price collapse.
There is always the chance we get another near 30% year because bubbles can always get bigger. It is possible we inflate our way out of this one at great long-term cost to safety-seeking investors in cash and lower risk bonds. This risk is the main reason we're not 80% cash and bonds now. We can't safely earn 5% in a 3% inflation world; we can only safely earn 1% in a 7% inflation world.
There are already signs this grand bubble era is ending. Trendy stocks trading on stories without earnings are already crashing — most are now in a bear market. Formerly hot funds like ARK Innovation ETF (ARKK) were down 23% last year, while the rest of the stock market went to the moon.
The real question for 2022 is whether this bear market in hype eventually drags the whole economy and market down, sort of like the dot com crash of 2000. Can the economy handle losing trillions in paper value in digital collectibles?
Or has the stock market become a metaverse, and it no longer matters what assets were valued at in the real world of the past?