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May 2021 Performance Review

June 3, 2021

The leadership in the market appears to have changed. Large cap growth and tech names are no longer driving the big gains and are even dragging on the market cap weighted indexes as smaller and cheaper stocks catch up, which benefits our current portfolios.

Our Conservative portfolio gained 1.95%, and our Aggressive portfolio gained 2.74%. Benchmark Vanguard funds for May 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 0.69%; Vanguard Total Bond Index (VBMFX), up 0.24%; Vanguard Developed Mkts Index (VTMGX), up 3.63%; Vanguard Emerging Mkts Index (VEIEX), up 1.73%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.64%.

This was one of our best months of relative performance during a positive month for stocks since the early 2000s, when our value and foreign stock and bond focus did well relative to U.S. large cap stocks, even in up markets. As we are generally taking less risk than the market, we beat on the way down by falling less with the aim of boosting our stock allocations at lower levels than of more closely matching the eventual recovery.

The main problem with this catching up phase of formerly underperforming stock categories is that we're fast approaching overvaluation of everything. It is not like anything was particularly cheap to begin with, more just a relative bargain compared to massive, large cap growth stocks. Keep in mind that most companies aren't growing that fast and don't really deserve very high valuations, though in a world of permanent zero rates, the notion of valuations is becoming less important to investors than predicting what people will desire in the future. This recent strong price action is almost alarming with our Vanguard Energy (VDE) holding up over 41.7% for the year and Vanguard Small-Cap Value (VBR) up 24.3%, compared to the S&P 500's more modest 12.7% gain.

Most of our stock funds beat the S&P 500 last month. Even our Nasdaq short fund was up slightly, highlighting the recent troubles of larger growth stocks. We're likely going to have to do another rebalance-oriented trade, cut back somewhat on stocks, and wait it out in cash and bonds. Ideally, interest rates would continue to go up, but even the big move up in rates from the lows of last year has flattened out, and we never even got to 2% on 10-year Treasury bonds. It is too early to tell if our recent buys of longer-term investment grade bonds came too soon, but those buys should offer us downside protection and something to sell to buy more stocks during the next slide.

The problem everywhere is the one we've been battling for years, which appears to get worse with every rebound in the economy and markets—too much money chasing for too few investments.

You can blame the Fed, but the money creation isn't really the direct issue; it's more the support of falling investments leading to investors overpaying for risky assets. The Fed put, so to speak, means that things won't really fall apart too far for too long before the Federal Reserve steps in to support prices till things get better, as we saw in the very troubled bond market last year, early in the pandemic. Minimal support can fix things as the Fed only spent a fraction of the trillions used to buy government debt last year to buy actual corporate debt and, somewhat controversially, distressed bond ETFs.

On top of this monetary crisis support, the government always seems to forget differences and toss money at problems. This leads to risky investments being priced as if there is little long-term risk because... Is there? As long as you are in good company (lots of investors making the same bet, be it in homes, bonds, or stocks) somebody has your back if things get too ugly. This support plus low borrowing costs (and therefore low cash and savings returns) leads to a collective movement—so why not join in, since you have more to lose by not gambling?

The other issue is that wealth grows fast and much of it is invested, not spent. Thomas Piketty laid this out in his 2014 economics bestseller, Capital in the Twenty-First Century. But where does all that growing wealth go? What if the supply of good investments can't keep up? In a world where wealth is taxed at a lower rate than income and wealth grows faster than income, the only natural limiting factor is poor investment opportunities: opportunities that are overpriced, or underwhelming, that can destroy wealth.

This has always been the main self-correcting mechanism to too much money—bad investment ideas. Imagine that we had never had 1929, or the dot com crash, or the housing crash. Wealth needs to be destroyed every so often to keep balance in the universe. You just don't want to be the one holding the bag when we go into wealth destruction mode, be it ever so brief.

The only real risk in such a supported market is relatively short term, the panic that sets in when trouble starts, where many want to get out and wait for the support to start. This selling can lead to cataclysmic drops followed by government action and fast rebounds. It seems that eventually, if these rebounds take us to ever higher valuations, this formula will stop working and we'll blow through the government support back to some level of valuations that more accurately adjusts for the heightened risk of investing. But can that even happen, if the Fed creates money and buys stocks, not just bonds, in a crash?

Living proof that we have too much cash sloshing around is the ongoing cryptocurrency boom. On some level, you could describe the whole affair as manufacturing collectible assets out of thin air to have a place to put all the money. How much more can go into trillion-dollar growth stocks and high-end collectibles like art, anyway?

Back in the short term, in our own portfolios last month, the leaders were Franklin FTSE Brazil (FLBR), up 9.6% as the out of favor, former high flyer of the 2000s, Brazil, may have hit rock bottom, at least to investors looking to time the rebound. Vanguard Energy (VDE) was up 6.55% as oil prices took off during our fast-overheating semi-post-Covid economy. All is not well in the long term in the energy business, as massive global efforts to phase out carbon and reward alternative energy could mean that big oil's best days are behind them. But then, there were good investment returns in cigarette makers well past their heyday, especially after weakness. At least the regulatory overhang is largely known to big oil. Big tech, on the other hand, is still living a largely government-free life as the increasingly obvious monopoly power these companies have has yet to lead to tangible major damage to these businesses—in fact, they are still allowed to buy up competitors more or less at will.

Much of our stock outperformance this month was because of a falling dollar, as can be seen directly in Invesco CurrencyShares Euro (FXE), which effectively owns euros, up 1.31%. Most fund categories were up last month, except for those with growth stocks, which were down 1—2%, typically. Convertible bond funds were down, as they have devolved into growth funds, due to excessive convertible bond issuance by booming tech stocks. Healthcare funds were down slightly, though our VanEck Vectors Pharma. (PPH) fund was up 3.78%.

We had three losers last month. ProShares Decline of Retail (EMTY), our inverse retail fund was down 1.45% as retail remains hot. Vanguard Extended Duration Treasury (EDV), our very long-term government bond fund, was down 0.11%. This fund was recently added back to the portfolio mostly because there is no cheaper way to add reliable protection from the next calamity, though there is risk here if rates take off again. Such a move would likely come with rising stock prices, so we should be fine with offsetting gains. Utility stocks were weak last month, with Vanguard Utilities (VPU) down 2.34%. Utilities are an area we may increase our (recently reacquired) allocation.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)9.60%
Vanguard Energy (VDE)6.55%
Vanguard FTSE Europe (VGK)4.45%
VanEck Vectors Pharma. (PPH)3.78%
Franklin FTSE Germany (FLGR)3.64%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.63%
Vanguard FTSE Developed Mkts. (VEA)3.58%
Vanguard Value Index (VTV)2.92%
Homestead Value Fund (HOVLX)2.57%
Vanguard Small-Cap Value (VBR)2.23%
Franklin FTSE South Korea (FLKR)2.01%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.73%
ProShares UltraShort QQQ (QID)1.51%
Invesco CurrencyShares Euro (FXE)1.31%
[Benchmark] Vanguard 500 Index (VFINX)0.69%
Franklin FTSE China (FLCH)0.40%
ProShares Decline of Retail (EMTY)-1.45%
Vanguard Utilities (VPU)-2.34%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)1.76%
Vanguard S/T Infl. Protect. (VTIP)0.77%
Vanguard Long-Term Bond Index ETF (BLV)0.33%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.24%
Vanguard Extended Duration Treasury (EDV)-0.11%