We may be seeing two different reactions to higher interest rates play out globally. Inflation is down, but US central bankers are still on high alert. Interest rates remain high, and bonds are down slightly for the year, though they have recently improved. US large-cap growth stocks are still white hot, while the rest of the stock market is only fair. Abroad, larger foreign markets are up less than 5% for the year after a weak June, compared to a roughly 15% return for the S&P 500 in 2024.
By moving into out-of-favor areas, our portfolios are positioned for a rotation from US large-cap growth stocks to bonds and smaller, more value-oriented global stocks—a market shift that hasn't happened yet, resulting in our performance lagging behind the S&P 500. Foreign stocks, including emerging markets, are still below 2021 highs, and bonds are down from 2020 highs.
There are signs parts of the real estate market are cracking under higher rates, notably commercial real estate, where sloppy high-risk lending is becoming apparent. While it is partially true that the worst aspects of the 2005 era real estate bubble—liar loans, no income no job (NINJA) loans, low down payments, excessive subprime loans—have been greatly reduced, the prime loans backing today's real estate boom may prove otherwise.
A recent article in the WSJ notes how commercial borrowers essentially lied about building revenues and expenses to get favorable loans, and lenders didn't look too closely. Many projects simply aren't going to work out at current high rates, as the income from the project can't handle higher payments. This has been a slow-moving crisis with extend and pretend arrangements, where defaults can be pushed off by not forcing borrowers' hands.
Perhaps this will devolve into the zombie loan era in Japan post-1989 twin stock and real estate bubbles, one that took decades to fully clear out of the system. The strong Japanese market (thanks to what else — chip stocks) broke the all-time intraday Nikkei 225 high set back in 1989. Can it happen here? Not likely, but it might if we lose the ability to respond to disasters either by bond investors being unwilling to buy more debt without demanding higher rates or the Fed losing the ability to create money to buy debt without causing high inflation.
Recent developments seem to reinforce US large-stock global dominance. Interest rates don't seem to be dragging on our economy much, which is astounding considering the high prices in real estate matched with now high mortgage rates. Abroad, perhaps due to weaker economic foundations, fewer long-term rate-locked mortgages, minimal AI boom, or just less deficit spending compared to the USA, currencies are weakening and the economy is sluggish. We are increasingly standing alone, except for maybe India, which has been a lone standout in strong stock market performance over much of the last decade.
Funds investing in India were up almost 7% last month, the top showing for all fund categories, and are now up over 13% for the year, the only single country fund category up double-digits this year except for the US. The gap with China and Latin American funds is astounding over the last 5 years—double-digit annual returns vs. negative returns. Part of this is political risk, but much of it is what happens to hot markets. About 15 years ago, China and Latin America were the hot areas to invest with scorching hot returns over the early 2000s until they crashed hard. This should be a warning to investors in large-cap tech stocks now, as well as in India. There is no way to know when the reversal of stock market fortunes will happen, but it is usually close to when money starts flowing out of poorly performing areas into hot markets and a bigger performance gap appears between the hot and not areas.
Utilities took a dive last month, offering a possible re-entry point. The bubble in energy-intensive AI, on top of energy-intensive crypto mining, ongoing shifts to electricity-guzzling EVs, and higher temperatures seem to offer good fundamentals for energy consumption for the foreseeable future.
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We may be seeing two different reactions to higher interest rates play out globally. Inflation is down, but US central bankers are still on high alert. Interest rates remain high, and bonds are down slightly for the year, though they have recently improved. US large-cap growth stocks are still white hot, while the rest of the stock market is only fair. Abroad, larger foreign markets are up less than 5% for the year after a weak June, compared to a roughly 15% return for the S&P 500 in 2024.
Our Conservative portfolio gained 0.12% in June, and our Aggressive portfolio declined 0.57%. Benchmark Vanguard funds for June 2024 were as follows: Vanguard 500 Index Fund (VFINX) up 3.58%; Vanguard Total Bond Index (VBMFX) up 0.93%; Vanguard Developed Mkts Index (VTMGX) down 1.91%; Vanguard Emerging Mkts Index (VEIEX) up 2.17%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.02%.
By moving into out-of-favor areas, our portfolios are positioned for a rotation from US large-cap growth stocks to bonds and smaller, more value-oriented global stocks—a market shift that hasn't happened yet, resulting in our performance lagging behind the S&P 500. Foreign stocks, including emerging markets, are still below 2021 highs, and bonds are down from 2020 highs.
There are signs parts of the real estate market are cracking under higher rates, notably commercial real estate, where sloppy high-risk lending is becoming apparent. While it is partially true that the worst aspects of the 2005 era real estate bubble—liar loans, no income no job (NINJA) loans, low down payments, excessive subprime loans—have been greatly reduced, the prime loans backing today's real estate boom may prove otherwise.
A recent article in the WSJ notes how commercial borrowers essentially lied about building revenues and expenses to get favorable loans, and lenders didn't look too closely. Many projects simply aren't going to work out at current high rates, as the income from the project can't handle higher payments. This has been a slow-moving crisis with extend and pretend arrangements, where defaults can be pushed off by not forcing borrowers' hands.
Perhaps this will devolve into the zombie loan era in Japan post-1989 twin stock and real estate bubbles, one that took decades to fully clear out of the system. The strong Japanese market (thanks to what else — chip stocks) broke the all-time intraday Nikkei 225 high set back in 1989. Can it happen here? Not likely, but it might if we lose the ability to respond to disasters either by bond investors being unwilling to buy more debt without demanding higher rates or the Fed losing the ability to create money to buy debt without causing high inflation.
Recent developments seem to reinforce US large-stock global dominance. Interest rates don't seem to be dragging on our economy much, which is astounding considering the high prices in real estate matched with now high mortgage rates. Abroad, perhaps due to weaker economic foundations, fewer long-term rate-locked mortgages, minimal AI boom, or just less deficit spending compared to the USA, currencies are weakening and the economy is sluggish. We are increasingly standing alone, except for maybe India, which has been a lone standout in strong stock market performance over much of the last decade.
Funds investing in India were up almost 7% last month, the top showing for all fund categories, and are now up over 13% for the year, the only single country fund category up double-digits this year except for the US. The gap with China and Latin American funds is astounding over the last 5 years—double-digit annual returns vs. negative returns. Part of this is political risk, but much of it is what happens to hot markets. About 15 years ago, China and Latin America were the hot areas to invest with scorching hot returns over the early 2000s until they crashed hard. This should be a warning to investors in large-cap tech stocks now, as well as in India. There is no way to know when the reversal of stock market fortunes will happen, but it is usually close to when money starts flowing out of poorly performing areas into hot markets and a bigger performance gap appears between the hot and not areas.
Utilities took a dive last month, offering a possible re-entry point. The bubble in energy-intensive AI, on top of energy-intensive crypto mining, ongoing shifts to electricity-guzzling EVs, and higher temperatures seem to offer good fundamentals for energy consumption for the foreseeable future.
In our own portfolios, the only strong areas were shorting bitcoin and retailers and our stake in Franklin FTSE South Korea (FLKR), which was having a bad year until last month. Our other single country funds performed poorly, down between 3 and 5% for the month, much of this due to currency weakness. This is why Invesco CurrencyShares Euro (FXE) was down 1.13% and iShares JP Morgan Em. Bond (LEMB) was down 1.16%, even though lower rates pushed Vanguard Extended Duration Treasury (EDV) up 2.5%, clawing back losses for the year.
Somewhat wild swings in interest rates recently and steady tech stock booming could mean a rough late 2024.