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September 16, 2020

We placed a few trades in both our model portfolios late on Friday, September 11th. The relatively minor changes were primarily to shift us out of some areas that had been hot and to add some lagging stock categories.

The rebound in stocks from the crash levels earlier this year has been a little too fast and furious, even adjusting for the low interest rates—if you can ever really adjust for low interest rates! This issue is particularly a problem with U.S. technology stocks, which are rapidly getting expensive, even beyond what incredibly successful near monopolies can be worth with near zero interest rates.

In our Conservative portfolio, we added a 5% stake in Vanguard Utilities ETF (VPU), a previous holding that has lagged recently relative to the tech-fueled stock market and is now worth buying again given its yield of around 3.4%, which should be inflatable over time and is very attractive compared to bonds today. You could get a higher yield in energy stocks (which we still own), but these represent a riskier yield. Real estate fund dividends aren't as attractive either and are possibly the most at risk of serious trouble as we possibly approach a once-in-a-generation downward adjustment to rents—at least in cities. We also dumped our 5% stake in iShares Edge Quality Factor (QUAL) after a roughly 31% gain since April. Cash-rich and low-debt companies benefit from being well positioned to manage best in a Covid-troubled economy. This positioning also means lots of tech holdings, but we don't want that exposure right now.

Specifically, in the Aggressive portfolio, we added a Brazil ETF, Franklin FTSE Brazil ETF (FLBR) to be exact, for a 6% allocation and purchased an "oldie but goodie" Utility ETF Vanguard Utilities ETF (VPU) for a 5% stake. We cut back our BRIC (Brazil, Russia, India, China) ETF iShares MSCI BRIC (BKF) from 6% to 0%, because it is now cheaper to own the countries we want to be in directly, partially thanks to the newish, very low fee, single-country ETFs from Franklin.

We also cut back our stake in Schwab US TIPS (SCHP) from 14% to 9%, because inflation expectations are rising and inflation-adjusted bonds now need pretty high inflation just to break even with regular treasury bonds. Typically, these bonds are purchased when investors are not worried about inflation, as was the case a few months ago. In fact, too high an inflation expectation can accelerate losses in a stock market crash as investors start to think that deflation is more likely. Overall, the bond market is becoming increasingly dangerous with so much money being put in by investors despite corporate bonds barely yielding more than Government debt, even with a high default risk from Covid-related economic disruptions.

We also sold our now almost nonexistent stakes (from massive declines) in an inverse leveraged Nasdaq ETF and an inverse gold mining stock ETF. Basically, we only made money by shorting oil in recent years. The Nasdaq deserved some of the increase as the world moved even more toward a plugged in Internet-based world (sadly) thanks to Covid, but it could still fall from these high levels. We need a new fresh position (which will also decline if Tesla and the other big names climb to even more ridiculous levels) with less leverage, in case we get big rebounds on the way down.

Gold mining stocks should do what they have done over the last 30 years—which is to go nowhere—and gold itself is only going up because holding money and short-term bonds is a loser position now. Covid has sent the demand for jewelry down by almost half—all the excess production has been picked up by ETFs that own gold and other speculations (future supply …). The short-term risk here is too high, especially with negative inflation-adjusted interest rates and a new gold bubble forming. Buffett's Berkshire Hathaway just bought a stake in a gold mine—even though Buffett has been a long-time critic of gold as an investment—after selling off an airline at a loss that he had only recently added to—that is how weird a world we are in at the moment.

We added an inverse offline retailers ETF as a possible good hedge against a second slide in stocks brought on by a potential fall in Covid cases. The concept is a little strange as all the retailers in the fund sell online as well has have big retail footprints, but then they could be hit with the double whammy of lost retail traffic and trouble competing with the ever-growing Amazon and other online tech giants squeezing the smaller retailers selling online.

As ETF trading is now free at TD Ameritrade (where these model portfolios are traded with real money) and basically all the other major brokers, we did some small rebalancing trades just to get our allocations back to where we want in some positions, but avoided cutting back in other areas that are up in order to avoid having too much in short-term capital gains (relative to the losses in inverse funds realized with this trade). This includes Franklin FTSE South Korea (FLKR), up around 50% since bought in our Conservative portfolio in April. In general, you almost never want to realize short-term taxable gains as no trade is worth the extra tax bite unless you have losses or could have losses elsewhere to offset the gains. Use your own tax situation and account type (IRA or taxable) to judge how much rebalancing you should do or to decide if you should hold off on some sales until short-term gains become long-term gains.

One area with a risk of future underperformance for us here is if U.S. stocks keep going up and up, notably tech stocks. By having larger foreign stock allocations we are basically avoiding tech stocks as most foreign countries have few top tech companies. In the longer run, it really depends on how much of the global economies' profits are going to be sucked up by a handful of tech giants that are increasingly in the middle of everything (so much for disintermediation) before regulations or taxes change the game significantly for these giants.

The main case for increased stock prices is almost guaranteed negative real (inflation adjusted) interest rates for years. This means Central Bankers are targeting say 2% inflation yet manipulating interest rates to around zero (some of this is just massive bond buying by the public). Losing 1%—2% of your money every year with the potential for 10%—30% hits if rates go up fast is not an appealing investment and makes even the most expensive stock make sense over time. Imagine if we had a 10% guaranteed negative real interest rate, say 0% interest rates and 10% inflation, is there any price that Apple stock would lose money over 10 years relative to bonds? Apple can just charge 10% more each year for iPhones and their cut of app sales will inflate with everything else and they could increase their dividends by 10% a year with no real change in their business. Deflation is far worse for business, and the Fed knows it.

In targeting 2% inflation with negative interest rates, the Fed creates almost limitless upside to inflatable asset prices—yet still will have trouble getting real world inflation to 2% when considering things like rents and energy and food. It would be much safer for the markets and economy to just create money and give it to people to spend and slow the Fed debt buying with newly created money or 'quantitative easing', but as creating money to spend directly is the historical recipe for rampant inflation in various countries, Central Banks are naturally scared of that strategy, but creating money that flows into investment speculation could be even more dangerous. Does it really make sense for companies to borrow their way out of the Covid mess because rates are low instead of issuing stock?

In closing, any market that pushes up a Tesla wannabe (Nikola...are you kidding me with this name?) that smells like a penny stock scam on steroids to a market value greater than Ford with no real path to profitability is a sign of a dangerous market distorted by low rates and a Robinhood-trading-app-stock-gambling culture.