Never miss a trade! Sign up for MAXfunds Powerfund Portfolio’s FREE email alerts! CLICK HERE!

December 2018 Performance Review

January 10, 2019

On Christmas Eve in this very rocky December, the stock market, as measured by the S&P 500, was down 20% from its October peak. Technically, this wasn't officially a bear market as the price slide from the peak closing value in the S&P 500 to the bottom in late December was just shy of 20%. Officially, the market needs to be down 20% from a market close to market close. Unofficially, this is a silly concept, and any 20% drop from a high in the market should qualify as something bigger than a "correction" (itself an overly positive term), which is a 10% drop. Whatever you want to call it, we haven't had many of these drops since the 2009 bottom, which is one reason investors are skittish—the good times have to end eventually, right?

Any way you slice it, December was the sort of month where the benefit of not taking on too much risk and avoiding popular strategies worked, basically the opposite tack from the previous months.

Our Conservative portfolio declined 0.35% in December. Our Aggressive portfolio fell 1.66%. Benchmark Vanguard funds for December 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 9.04%; Vanguard Total Bond Market Index Fund (VBMFX) up 1.80%; Vanguard Developed Markets Index Fund (VTMGX) down 5.37%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.97%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 4.73%.

December was among our best performances relative to the S&P 500 since these model portfolios started in early 2002. It's way too early to brag, and we were lagging during the last months of this bull market such that our returns relative to the stock market are still so-so. Still, if you like sleep-at-night downside risk, it was a good near-bear market for us.

For 2018 as a whole, our performance was underwhelming but acceptable. Our Aggressive portfolio was down 5.24% compared to the negative 4.52% showing for the Vanguard 500 fund in 2018 (with dividends). Our Conservative portfolio dipped just 2.81%. The Vanguard Star fund, our globally balanced benchmark, was down 5.34% for the year. What was most interesting about 2018 was how lousy "diversified" portfolios did, even ones that are balanced with bonds and stocks. Vanguard Star Vanguard Star Fund (VGSTX) is 60% stocks and 40% bonds, and it fell more than the S&P 500 and our portfolios.

2018 was the worst year for a globally balanced portfolio since 2008. This was largely because bonds were down significantly in 2018, especially longer-term and higher-credit-risk bonds, and foreign markets were down sharply. Just looking at market gyrations up and down, we're taking less risk than the market and less even than most balanced funds. According to one hedge fund tracker, the average hedge fund fell over 4% in 2018 as the highest-paid experts in minimizing downside had trouble doing just that.

The few positive return areas in December (if not the year) included longer-term and investment-grade bond funds like those we own in the portfolios. All bond funds except short-term bond funds with limited interest rates and credit exposure (including our holdings) were actually down for the year. Still, the rebound in bond funds in December was a key reason our portfolios didn't fall much during this rough month.

Higher-yield, higher-credit-risk bonds performed poorly for the year and month as these areas tend to have near-stock-market downside during market corrections and less upside than stocks during rebounds. Selling our position in Artisan High Income Fund (ARTFX), a higher-credit-risk bond fund, in June proved timely as this fund, which was up solidly in 2016 and 2017 and early 2018, slid 5.27% in the last three months of 2018 year.

The only fund sector in positive territory in 2018 was utilities. Our own Vanguard Utilities (VPU) holding was down 4.12% in December but still delivered a positive 4.37% for the year. After technology, utilities have shown the highest returns over the last five years in sector mutual funds, sort of amazing in this growth-oriented market. Considering the lower down side, the risk/reward has been very good.

Unfortunately, our inverse MLP (Master Limited Partnerships) fund was shut down for lack of investor interest in 2018 right before shorting energy-related investments started working very well. This could have helped our Conservative portfolio score even better numbers in 2018. MLPs fell as much as 20% in the last three months of 2018 and were down double-digits for the year. Our oil short PowerShares DB Crude Oil Dble Short (DTO) was up 18.59% after a 45%+ gain the previous month, yet only delivered a 13.77% return for the year. The smart move would have been doubling up on this holding when the short MLP fund was closed.

Shorting in general obviously worked well in December, except for shorting gold. Proshares Ultrashort Russel2000 (TWM) was up 26.35% for the month for a 19.19% year, while Proshares Ultrashort NASDAQ Biotech (BIS) gained 24.40% but was only up 5.18% for the year.

Conceptually, our call to favor large cap and short small cap in recent years was right in the sense that large cap funds were up 6.6% on average per year over the last five years, while small cap funds were only up 3.2%. The gap was even bigger between large cap growth and small cap value—the latter up just 1.86% per year over the last five years. But, as we noted, there were no ETFs with which to do that other than shorting small cap value ETFs directly. Our short positions in inverse ETFs dwindled during the booming market (because they are flawed products) such that the offsetting gains where limited here.

So, is this a dip to buy or the start of a 50% slide?

When the market broke down in 2007 and 2008, we saw similar relative performance benefits in our portfolios compared to falling benchmarks. We also increased the risk level on the way down in that bear market by increasing our stock allocation. This worked when the eventual recovery hit. We have no way of knowing if this market slide will continue or rebound quickly (as it did after the 2011 slide and appears to be happening in January so far). Either way, a 20% decline is an opportunity for any portfolio that isn't on a fixed-risk level (say, 60% stocks, 40% bonds permanently) to start increasing risk. If the market goes down 50%, we aim to be as aggressive as we were in early 2009, meaning our downside risk can start increasing on the way down in order to boost our upside.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)26.35%
Proshares Ultrashort NASDAQ Biotech (BIS)23.40%
PowerShares DB Crude Oil Dble Short (DTO)18.59%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.97%
iShares MSCI Italy Capped (EWI)-3.36%
Vanguard Utilities (VPU)-4.12%
Vanguard European ETF (VGK)-4.86%
iShares MSCI BRIC Index (BKF)-5.18%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-5.37%
Vanguard Europe Pacific ETF (VEA)-5.70%
iShares Global Telecom ETF (IXP)-6.45%
Homestead Value (HOVLX)-7.94%
Vanguard Telecom Services ETF (VOX)-8.27%
[Benchmark] Vanguard 500 Index (VFINX)-9.04%
Gold Short (DZZ)-9.08%
Vanguard Value (VTV)-9.16%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)8.06%
Vanguard Long-Term Bond Index ETF (BLV)4.36%
SPDR Barclays Intl. Treasury (BWX)2.09%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.80%
Vanguard Mortgage-Backed Securities (VMBS)1.66%
Dodge & Cox Global Bond Fund (DODLX)0.89%