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August 2018 Performance Review

September 6, 2018

U.S. stocks were hot again in August while foreign stocks were very much not. At this stage it looks like the U.S. is winning the trade war, but some of this global stock divergence could be due to frightened international investors moving funds into the U.S. from suddenly scary looking emerging market stocks and bonds. There are now at least three economies in some form of economic chaos — Venezuela, Argentina, and Turkey.

Our Conservative portfolio fell 0.15% in August. Our Aggressive portfolio declined 0.77%. Benchmark Vanguard funds for August 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 3.25%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.52%; Vanguard Developed Markets Index Fund (VTMGX) down 1.91%; Vanguard Emerging Markets Stock Index (VEIEX) down 3.55%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.17%.

The small gains for our value/income focused U.S. stock funds (and even smaller gains from U.S. bond funds) were more than swallowed up by losses in anything foreign last month, stock or bond. The Vanguard STAR fund we aim to beat over time not only has more in stocks (60%) and less interest rate exposure but also has more of the stock allocation in U.S. stocks (40% U.S. / 20% non-U.S. Our net stock exposure in our Aggressive portfolio in real money now is about 28% US to 22% foreign In Conservative we are just under 20% US / 16% foreign).

Notably weak recently have been Italian stocks; sending our iShares MSCI Italy Capped (EWI) position down 9.27% for the month. Investors want to avoid being invested in the next crisis economy abroad. Politically questionable and leveraged Italy sitting on a rocky economic foundation seems a likely trouble spot.

The hottest areas in the U.S. were growth stocks, notably smaller cap growth stocks, up 7.65% for the month and capping a 32%+ twelve-month streak. The five-year leader remains larger-cap growth, the category where all the tech giants live.

The coldest August performers were foreign stocks with Latin American stocks sliding just shy of 10% — double the next worst performer China. This was not good for our iShares MSCI BRIC Index (BKF) position last month. Latin America is really the only stock fund category down over the last five years.

In sectors, technology was again the top gainer up 6.11% for the month and the one-year leader at 28%. Some famous managers that underperformed much of the last decade by being too heavy in foreign and value stocks are finding new focus in tech and healthcare This is likely a mistake. Such performance chasing will be a drag over the next ten years.

This recently intensifying performance gap in foreign vs domestic stocks really started around the last bear market in 2007. Some of the gap can be chalked up to currency changes as the dollar's long slide in the early 2000s reversed course over the last decade or so, but a lot more of it has to do with investors putting too much money abroad in the early to mid-2000s. They bid up international stock prices too high relative to U.S. stocks and we're still working it off. The gap is also widened by the sheer domination in technology companies in the United States and the relatively strong U.S. economy.

That said, China has big powerful tech companies and even more economic growth and the main China ETF (FXI) price is still down over 40% from the bubble peaks of 2007 (though with dividends an investor is only down about 25% over a decade later). The fund asset level is down around half from the near $10 billion peak and the fund is sitting on a couple of billion in realized losses because the average investor lost money in China and most other hot then not funds. Come back and look at U.S. biotech ETFs in ten year's you will see a similar pattern.

Looking just at ETF cash flows this year (where most of the hot money goes now) investors moved money out of U.S. stocks during the brief slide early this year and into foreign stocks — which turned out to be exactly the wrong move as U.S. stocks rebounded and foreign stocks dropped.

Even without a bear market the performance pendulum should swing back to foreign stocks as it did after the late 1990s performance run by U.S. growth stocks.

Looking back over the last 9+ years of this historic bull market with no drops over 20% (the definition of a bear market) along the way, our main performance problem was not sticking with our U.S. growth focus and a high stock allocation well after the last crash — these trends tend to last longer than you expect. There was too much money still going abroad over the last few years for foreign to be the bargain of the early 2000 era.

Ideally, we'd get another full-blown emerging market crash. This ultimately could lead to the sort of pricing where you can get back into the high-single low-double digit stock returns for taking on higher risk. Today there is plenty of downside risk in the U.S. market and just mid-single digit upside.

Stock Funds1mo %
Gold Short (DZZ)4.99%
[Benchmark] Vanguard 500 Index (VFINX)3.25%
Vanguard Telecom Services ETF (VOX)2.83%
Homestead Value (HOVLX)2.13%
Vanguard Value (VTV)1.90%
Vanguard Utilities (VPU)1.15%
iShares Global Telecom ETF (IXP)-0.10%
Vanguard Europe Pacific ETF (VEA)-1.73%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.91%
Vanguard European ETF (VGK)-2.83%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.55%
iShares MSCI BRIC Index (BKF)-4.77%
PowerShares DB Crude Oil Dble Short (DTO)-5.56%
Proshares Ultrashort Russel2000 (TWM)-8.11%
Proshares Ultrashort NASDAQ Biotech (BIS)-9.20%
iShares MSCI Italy Capped (EWI)-9.27%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)1.65%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.52%
Vanguard Mortgage-Backed Securities (VMBS)0.50%
Vanguard Long-Term Bond Index ETF (BLV)0.48%
SPDR Barclays Intl. Treasury (BWX)-0.62%
Dodge & Cox Global Bond Fund (DODLX)-1.20%