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November 2016 Performance Review

December 7, 2016

It was a November to remember.

November was Donald Trump's month in the markets. Nobody saw him winning much less U.S. stocks going up in the wake, but weirdly many of the stocks that did well after the surprise Trump victory started doing so before the election. Maybe this oddity — which could be a mere coincidence — will show up in the fake news that permeates the conspiracy circles online. Talk about a bull market…

One global equity strategist for Barclays — one of the largest asset managers — predicted that in the event of an unlikely Trump win stocks would fall around 7%. Wrong and wrong.

The most important takeaway for investors here is no matter how you feel about Trump, don't stop investing and hide for four or eight years waiting for America to burn. (That is a fire that some have expected since the dawn of the republic.) I said the same thing over the last eight years to those who were certain that Obama was going to destroy America and its economy. Those who stayed in cash, commodities, and gold — perhaps with seed and water-purifiers— missed out on perhaps the greatest average annual returns in stocks during any president's time in office. I'm trying not to jinx it…

The political pendulum has swung, but that doesn't mean Trump will destroy the economy either. Around half of the people probably think his policies will help the economy. This doesn't mean your portfolio needs to look the same as it did in 2009. The scary period after the Trump victory was in the first few hours. Futures that trade on stocks after hours were down sharply — like 5% sharply. This trend reversed by the time regular trading began and became the full-fledged "Trump rally" that is now getting too much attention in the press. Sort of like Trump.

While there were some intriguing moves up and down post-Trump — biotech stocks moved up, maybe because of less political heat on pricing — the overall global asset picture was not impressive. The total value of all assets declined, while the U.S. stock market and U.S. dollar "won." We have a global portfolio of stocks and bonds that is tied fairly highly to interest rates and took a blow.

As an example of how fleeting the Trump bump can be, and the inherent unpredictability of Trump policy can be, Biotech stocks are now (as of December 7th) falling fast on a comment from Trump that, "I`m going to bring down drug prices. I don`t like what has happened with drug prices." It's like having Bernie Sanders, Ross Perot, and Ronald Reagan share the presidency.

Our Conservative portfolio declined 3.50%. Our Aggressive portfolio declined 2.76%. Benchmark Vanguard fund performance for November 2016 was as follows: Vanguard 500 Index Fund (VFINX) up 3.70%; Vanguard Total Bond Market Index Fund (VBMFX) down 2.64%; Vanguard Developed Markets Index Fund (VTMGX) down 1.53%; Vanguard Emerging Markets Stock Index (VEIEX) down 4.36%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.41%.

It is very rare to see these benchmarks down so much relative to the S&P 500. Of the over 100 fund categories (large-cap value, technology, muni bond, small-cap growth, utilities, etc.), about 85% underperformed the S&P 500 in November. The average category was down about a half percent. Considering that most fund categories are composed of U.S. stocks, this wasn't a very good month overall. If you factor in real estate prices, which likely slipped with rising rates, global wealth almost certainly declined.

Our portfolios also underperformed the S&P 500. All the bond funds were down, with long-term bond funds such as Vanguard Long-Term Bond Index ETF (BLV) down 6.3%, while SPDR Barclays Intl. Treasury (BWX) slid 5.72% on the double hit of a rising U.S. dollar and falling bond prices with rising yields. Only our gold short fund Gold Short (DZZ) scored a big win — up 17%. We did well with value funds: Vanguard Value (VTV) up 6% and Homestead Value (HOVLX) up 5.66%. Besides shorting stocks, which was a disaster, utilities and our foreign funds were down for the month. While both are still up for the year, we are now well behind the S&P 500's near 10% rise with dividends.

As an investor, the question is: does this continue and the U.S. dollar and U.S. stocks become "great again" at the expense of other assets, in a Trumpian zero-sum game where we win only if Mexico and China start to lose? Unlikely. We're near the tail end of a long run in the U.S. dollar, which is why we are fairly heavy abroad now in the first place, which is not how our portfolios looked in 2008.

The problem is that it's hard to win without everybody winning on some level. We can put punitive tariffs on imports and give tax breaks to those that play by the new rules, but eventually, others will do this; for every 1,000 jobs that are "saved" here, we'll lose as many to another country that's trying to save its jobs. And all the while, governments around the world go broke by lowering taxes and increasing spending, while incentivizing companies to stay put pushing interest rates and borrowing costs up as borrowing increases to finance the gap in revenues and spending.

So why do investors seem to like the current situation? It is unlikely that if Bernie Sanders won the election and proposed similar anti-free trade initiatives to solve income inequality and boost the pay of the working person, Wall Street would cheer. It is possible that companies will benefit at the expense of governments (stop clapping) as tax incentives and bribes to fight the natural forces of globalization lead to higher after-tax profits, while consumers spend more as after-tax wealth increases. This scenario assumes tariff trade wars don't start, we don't get buried in debt with increasing rates needed to entice our new enemies abroad to buy, and economic growth increases enough to cover these shortfalls.

This all could just be the trigger event for investors to pile back into U.S. investments after years of investing abroad instead of in underperforming U.S. markets. The latest fund flow data shows investors leaving foreign markets and going into U.S. stocks post-election. This could be short lived and lead to foreign funds outperforming again soon. Late 2014 was a period of down foreign markets and up U.S. markets, and investors started to favor U.S. markets heavily for a few months. Foreign markets then spent the next few months outperforming U.S. markets. Or this trend could signal the end of the popularity of foreign investing, much like what happened in the late 1990s, eventually setting us up for years of foreign stock outperformance like the first part of the 2000s as the U.S. sinks.

The main question here is how high can interest rates go on expectations of a higher growth economy after a Trump tax-cut-and-spend stimulus package, one that presumably will kick in without a recession in place or particularly high unemployment. Global interest rates are very low for a reason; most countries face deflation and weak economies. If our rates go way up relative to other countries, the dollar will continue rising until it causes economic and earnings problems for U.S. companies.

The strange part of this Trump rally is that all the "pre-Trump" stocks were getting expensive and popular — rate-sensitive plays such as utilities and "low-volatility" stocks. We were setting up for outperformance in "high beta" stocks like financials and energy as a contrarian call. Then Trump won, and the fix happened in days. Bummer for us still stuck in October's portfolio, although we were migrating slowly to higher beta in client accounts this year. Too slowly. We weren't migrating because of a bold Trump prediction, but because the money was all going low risk, and taking on risk was going to pay off, as it did in November — with a bang. The proof, as we noted before, was the launch of dozens of low-volatility, "smart beta" ETFs and the almost total lack of new high beta or riskier-than-the-market funds.

Investments to consider adding or increasing post-Trump include:

TIPs — In theory, they offer more protection against rising inflation, though not against rising rates without much inflation. In that situation, they will do as poorly as regular bonds or worse.

Gold (to short) — Many of the calls for gold were based on American declinism, however unfounded that view was. A rising dollar and America being great again, even if that is a largely psychological phenomenon, could lead to those hoarding coins (and seed…) to unload and consider assets more tied to American prosperity.

High Beta — Risky and economically sensitive stocks and small-cap stocks have already done well in recent weeks, so big moves here, months before any policy change, could be too much risk based on expectations alone, but these are still a better idea than low-volatility stocks.

Oil (short) — While there may be some stocks that benefit, actual barrels of oil will get cheaper with more exploration. OPEC is already trying to get ahead of this new glut with production cuts that temporarily sent oil prices back up.

Foreign bonds — This could be risky in the short run, but in the long run, our dollar is near the top of how high it can go without self-correcting economic activity kicking in. Moreover, unless Trump-style politics spreads (beyond Brexit), you'd rather lend money to governments that don't increase spending and cut taxes. This is ultimately why buying, say, California Muni bonds worked out in recent years after panic lows post-2008. Those governments didn't cut taxes to try and grow out of the deficit; they raised tax revenue faster than spending. Stinks if you are a taxpayer; doesn't stink if you are a bondholder.

Emerging markets — Limit exposure to emerging markets, except maybe to Russia (our new BFF). Any plans to keep jobs in America doesn't hurt, say, Germany as much as it does emerging markets where those jobs were heading.

— Just because everybody is looking for the end of the great bull market in bonds doesn't mean interest rates are going back to 6% any time soon.

??? — This Trump investing guessing game can be dangerous, unpredictable, and not based on repeatable logic. Nobody knows what is going to happen. In general, we're going to keep the focus on less-favored investments and wait for the stories to push these areas back up in price, which is essentially what happened in recent weeks. I'm mad at myself, not for not predicting a Trump win and U.S. stock rally but for pushing off buying out-of-favor financials, energy stocks (not oil itself), and high beta stocks with more economic than interest-rate sensitivity. Trump was just the catalyst. Don't think of news driving the investment returns so much as the news following the investment returns — which in turn are driven significantly by how much money is trying to earn returns in various investments.

And to the half of the country that thinks the 1980s are back, there are many differences between 2017 and 1981. We're older. Taxes, interest rates, and inflation are already low. The debt is far higher as a percent of GDP. The current stock-market dividend yield is a lot smaller, and the P/E ratio is a lot higher. Bidding up stocks valuations significantly based on expectations of greatness could make the next crash more like 1929 than 1987.

Stock Funds1mo %
Gold Short (DZZ)17.05%
Vanguard Value (VTV)6.00%
Homestead Value (HOVLX)5.66%
[Benchmark] Vanguard 500 Index (VFINX)3.70%
Vanguard Telecom Services ETF (VOX)3.25%
iShares Mortgage REIT (REM)1.22%
Artisan Global Equity (ARTHX)-1.19%
Vanguard Europe Pacific ETF (VEA)-1.51%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.53%
Vanguard European ETF (VGK)-2.34%
iShares MSCI BRIC Index (BKF)-3.26%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-3.37%
iShares MSCI Italy Capped (EWI)-3.90%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.36%
Vanguard Utilities (VPU)-4.54%
PowerShares DB Crude Oil Dble Short (DTO)-7.04%
Proshares Ultrashort NASDAQ Biotech (BIS)-16.03%
Proshares Ultrashort Russel2000 (TWM)-19.77%
Bond Funds1mo %
Artisan High Income Fund (ARTFX)-0.23%
Vanguard Mortgage-Backed Securities (VMBS)-1.82%
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.64%
SPDR Barclays Intl. Treasury (BWX)-5.72%
Vanguard Long-Term Bond Index ETF (BLV)-6.30%
Vanguard Extended Duration Treasury (EDV)-11.49%