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August 2019 Performance Review

September 7, 2019

Stocks gave back some of the gains made in August as economic and trade fears kept bubbling up. In this environment the bond market remained red hot as interest rates plunged yet again. This boosted our portfolios relative to benchmarks as we have been taking more interest rate risk (but less stock risk) than most other portfolios for quite a few years now. The stock market is still up around 18% for the year, including dividends, although it is up only about 2.8% over the last 12 months, as that includes the big slide late last year.

Our Conservative portfolio gained 1.93%. Our Aggressive portfolio gained 1.07%. Benchmark Vanguard funds for August 2019 were as follows: Vanguard 500 Index Fund (VFINX), down 1.59%; Vanguard Total Bond Market Index Fund (VBMFX), up 2.78%; Vanguard Developed Markets Index Fund (VTMGX), down 1.91%; Vanguard Emerging Markets Stock Index (VEIEX), down 3.76%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.56%.

The 30-year U.S. government bond recently yielded less than 2%. This is a record low but is still quite a bit higher than foreign government bonds, many of which have negative yields. This partly explains the sudden attraction to the bond market here, though this phenomenon has been in place for quite some time — years, actually. Foreign investors aren't the only ones buying bonds; fund investors here have added tens of billions of dollars to bond funds, as fears circulate that the next recession will probably lead to another 50% drop in stocks, like the last two did — fool me thrice, shame on me. The problem with this strategy is that during the last two recessions, interest rates started high and you made money in higher-grade bonds as stocks and yields declined. We're at recession level interest rates but with boom time stock prices.

This bond market action led to some wild gains in our longer-term bond funds last month, notably with the ultra-rate-sensitive zero coupon bond ETF Vanguard Extended Duration Treasury (EDV) up 15.47% and Vanguard Long-Term Bond Index ETF (BLV) up 8.24%. These are the sorts of gains we'd expect in the next recession and big bear market, not during a time of low unemployment and near record levels in stocks.

Small caps, oil, and biotech were weak last month, leading to gains in most of our short positions as well, but not in our short gold ETN, which slid nearly 14%. Gold investors seem to think this is all going to end in inflation somewhere, or maybe now they are just trying to avoid the negative interest rates common abroad.

Looking ahead, the trouble is that we are running out of yield and upside in bonds. If stocks were very weak we'd definitely be switching from bonds to stocks. But stocks by many measures are also near historically high valuations, notably total market cap to GDP. Adding to the problems, shorter-term rates are going back down, with more drops on the way as the Fed tries to keep the economy out of recession and fight the yield curve inversion. We're also running large deficits, limiting our fiscal solutions to a future economic slowdown. Want more? Inflation isn't even that low, as it was a few years ago.

Small-cap value stocks had a surprisingly bad month with a drop of over 6%, while the S&P 500 was down just 1.6%. This has been a multi-year trend, with one of the widest performance gaps ever between large-cap growth stocks and small-cap value stocks over the last few years. As we noted years ago when we took on the inverse small-cap ETF while also owning larger cap growth funds, this was something we expected, but there was no small-cap value inverse ETF (just small cap in general) and no good way to make this bet over many years, other than merely avoid smaller cap value funds. Now it is time to consider the opposite position and shift from larger cap growth funds to smaller cap value.

It was all losses in overseas stocks, with the best of the losers being in Europe and Japan, down a mere 2%+, while emerging markets were down more in the 4—8% range. The best U.S. sectors last month were precious metals (up about 4.7%), utilities (up 2.7%), and real estate (up just over 2%). Pretty much everything else was down, especially the big 10% drop in energy, a sector that is actually looking interesting now after a terrible decade (roughly since the time everybody thought energy investing was such a great idea).

Best case: it is possible we've reached some sort of permanently high plateau in bonds and stocks, where there isn't going to be much upside in either but the economy is strong enough and inflation low enough (and the amount of money looking for investments great enough) that these markets sort of stick around these levels, but with some wild swings. Of course, in 1929, a few days before the 90% slide began, a now infamous economist said the stock market had reached what looked like a permanently high plateau, and destroyed an otherwise impressive career. Just on flows of money, which wildly favor bonds (unlike in 2000), stocks should beat bonds over the next 5—10 years. This doesn't matter much because right now everybody is concerned about the next 1—2 years.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)9.20%
PowerShares DB Crude Oil Dble Short (DTO)8.02%
Vanguard Utilities (VPU)4.83%
Proshares Ultrashort NASDAQ Biotech (BIS)4.49%
iShares MSCI Italy Capped (EWI)-0.44%
[Benchmark] Vanguard 500 Index (VFINX)-1.59%
Vanguard European ETF (VGK)-1.65%
Vanguard Europe Pacific ETF (VEA)-1.88%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.91%
iShares Global Telecom ETF (IXP)-2.61%
Vanguard Telecom Services ETF (VOX)-2.78%
Vanguard Value (VTV)-2.97%
Homestead Value (HOVLX)-3.60%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.76%
iShares MSCI BRIC Index (BKF)-4.00%
Gold Short (DZZ)-13.95%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)15.47%
Vanguard Long-Term Bond Index ETF (BLV)8.24%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.78%
SPDR Barclays Intl. Treasury (BWX)1.85%
Vanguard Mortgage-Backed Securities (VMBS)0.93%
Dodge & Cox Global Bond Fund (DODLX)-0.54%