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April 2016 Performance Review

May 4, 2016

The dramatic rebound seems to be running out of gas—or rather, oil.

Recently, corporate earnings have been weak while stock prices have been strong. This can't continue for long. Either earnings will have to head back up or prices will have to head down—otherwise, we'll have late-1990s-style high P/E ratios, only without the expectation for high earnings growth. That's not going to happen.

The oil rebound, which is critical to saving many emerging markets and most of the leveraged natural-resource money-making gambits hatched during the great oil run up, seems to have stalled. The third leg of the worry stool is China, which seems to be on the edge of sinking and dragging everybody else down with it.

On a positive note, interest rates remain low, and inflation is starting to look about as likely as eight-track tapes (another 1970s relic) staging a serious comeback.

Our Conservative portfolio gained 0.73% in April, and our Aggressive portfolio fell 0.53%. The Benchmark Vanguard funds for the month were as follows: Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) was up 0.37%; Vanguard Total Bond Market Index Fund (VBMFX) was up 0.38%; Vanguard Developed Markets Index Fund (VTMGX) was up 2.43%; Vanguard Emerging Markets Stock Index (VEIEX) was up 0.78%; and Vanguard Star Fund Vanguard Star Fund Vanguard Star Fund (VGSTX), a total global-balanced portfolio, gained 1.20%.

It wasn't our best showing since our aggressive use of shorts dragged on returns. Because most of our normal holdings beat the benchmark U.S. stock-and-bond index, we at least held onto our year-to-date lead. The Aggressive portfolio is up 3.31% YTD, and the Conservative portfolio is up 4.82% YTD. Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) is up 1.69% for the year; Vanguard Star Fund Vanguard Star Fund Vanguard Star Fund (VGSTX) is up 1.76%. For a recent downside comparison, Vanguard Star Fund Vanguard Star Fund Vanguard Star Fund (VGSTX) also fell 3.74% in January (the most recent month with a large drop), while our Conservative portfolio was down 0.59% and our Aggressive portfolio fell 0.46%.

We keep making lemonade out of the low rate lemons in the bond market. Our recent move back into unhedged foreign bonds with SPDR Barclays Intl. Treasury (BWX) is working out well, although the gains are mostly from the euro climbing relative to the dollar, as was the plan. Considering that rates aren't around 5%, like the last time we were heavy in foreign bonds in the early 2000s, this is pretty nice, and we've seen a near-10% return in just over a year. Who would have thought that moving into bonds with near-zero yields would have worked out?

As for bonds that still yield around 5%—junk bonds—our other recent foray back into this risky area through Artisan High Income Fund (ARTFX), which was up 3.75% last month, is helping. That fund's performance is one reason our Conservative portfolio is beating our Aggressive portfolio. These high-yield bonds are the riskier gains—not the euro-denominated investment-grade bonds—although they offer a better upside if the global economy improves.

Shorting was a disaster across the board; our gold, oil-related, and small-cap stock inverse ETFs all dropped significantly. What we are effectively doing here is building a strong counterweight to the small-but-growing threat of unbeatable deflation—the kind that can really hurt normal investments like stocks, non-government bonds, and real estate. All that is missing is a REIT short because using leverage to buy real estate will be a problem if deflation takes hold and rents head down.

The recently weakening U.S. dollar is helping our long investments, so again the balance seems right between the upside and the downside. Our Aggressive portfolio is probably (although you never really know) tuned to do better relative to the S&P 500 on the way down than it is on the way up. We'll adjust the allocation for more gains (with more downside risk) if we get a bigger drop in stocks than we saw earlier this year.

Most investors trying to reduce risk stick to cash and shorter-term investment-grade bonds with a small amount of dividend stocks. It's possible that pushing out the risk envelope in both directions—with longer-term bonds, junk bonds, foreign bonds, and more aggressive stock funds—can produce a higher return at a low risk level if you have offsetting movers. The possible risk is still higher if these strategies stop cooperating, but a true low-risk portfolio has such a low expected return, with rates near zero, that some added risk is necessary.

Stock Funds1mo %
iShares MSCI Italy Capped (EWI)4.18%
Vanguard European ETF (VGK)2.76%
iShares MSCI BRIC Index (BKF)2.46%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.43%
Vanguard Europe Pacific ETF (VEA)2.31%
Homestead Value (HOVLX)2.19%
Artisan Global Equity (ARTHX)2.18%
iShares Mortgage REIT (REM)1.65%
Vanguard Value (VTV)1.52%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.78%
[Benchmark] Vanguard 500 Index (VFINX)0.37%
Vanguard Telecom Services ETF (VOX)-0.19%
Vanguard Utilities (VPU)-1.95%
Proshares Ultrashort Russel2000 (TWM)-4.00%
Proshares Ultrashort NASDAQ Biotech (BIS)-7.92%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-12.10%
Gold Short (DZZ)-14.16%
PowerShares DB Crude Oil Dble Short (DTO)-30.58%
Bond Funds1mo %
Artisan High Income Fund (ARTFX)3.75%
SPDR Barclays Intl. Treasury (BWX)1.52%
Vanguard Long-Term Bond Index ETF (BLV)1.12%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.38%
Vanguard Mortgage-Backed Securities (VMBS)0.25%
Vanguard Extended Duration Treasury (EDV)-1.10%