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October 2021 Performance Review

November 7, 2021

The brief weakness in stocks in September didn't last. Any fears of inflation, stagflation, global supply shortages, and the like melted away as the S&P 500, with dividends, returned 7%, leading to a 5.13% three-month return and a whopping 24% year-to-date.

This 7% pop was higher than the monthly return of 95%+ of fund categories (stock and bond). It was also enough to get us to Dow 36,000, only 22 years after the then-famous bubble book of the same name was published in 1999. For the record, it took about 15 years for investors to break even on NASDAQ stocks purchased in early 2000 and about a decade for S&P 500 investors to be safely above the levels of the bubble top (the brief move above 2000 levels in the S&P 500 didn't hold through the 2007-09 crash).

Our Conservative portfolio gained 3.19%, and our Aggressive portfolio gained 3.16%. Benchmark Vanguard funds for October 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 7.00%; Vanguard Total Bond Index (VBMFX), down 0.03%; Vanguard Developed Mkts Index (VTMGX), up 3.15%; Vanguard Emerging Mkts Index (VEIEX), up 1.11%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.33%.

Our low allocation to US growth stocks was covered by strong returns in energy, utilities, and bonds, leading us to roughly match the Vanguard global balanced fund, which is a bit riskier (more stocks and downside) than our portfolios. It was another late 1990s market, where everything sort of underperforms large-cap growth stocks in the US.

Our hottest fund was Vanguard Energy (VDE), up 11.21%, as inflation fears and consumer demand drive oil ever higher. It is almost unbelievable to consider that a little over a year ago we had zero-dollar oil futures and everyone writing oil off as yesterday's investment destined to go the way of the buggy whip, and ultimately the internal combustion engine.

Now there are gas lines in the UK and Russia is sitting in the natural resource catbird seat. While the good times could last, this area needs to get cut back from portfolios, if for nothing else, as protection from the next economic slowdown, which will break the oil markets again. Vanguard Utilities (VPU) was up 6.01% as interest rates drifted back down, boosting the value of this high dividend income area. Everything else we owned underperformed the S&P 500, though only Brazil stood out as a big loser (not including shorting), with Franklin FTSE Brazil (FLBR) down a big 9.17% as emerging markets in general are falling out of favor, kicked off by China's ongoing troubles.

This fear of foreign emerging market risk pushed iShares JP Morgan Em. Bond (LEMB) down 1.18% during an otherwise good month for bonds that saw our Vanguard Extended Duration Treasury (EDV) holding climb 3.52% and Vanguard Long-Term Bond Index ETF (BLV) up 1.72%.

Other hot areas in October were precious metals funds, which jumped almost 10% in an otherwise terrible year where they are still down for the year - surprising to those who believe that gold is the ultimate protection against inflation.

It must be aggravating to gold bugs to finally (after waiting for so many years!) get inflation to jump significantly only to watch in horror as gold- and silver-related investments slide. To add insult to injury, the new anti-dollar investment all the youngsters can't stop blathering about - cryptocurrencies - are up big. We've read stories about the supposedly uncomfortable holiday season as families with, let's say, differing COVID policies get together, but what of breaking bread while sitting on a pile of 'precious' metal coins bought from some TV ad about Armageddon only to hear some younger family members talking about their digital currency riches?

Understandably, with interest rates below inflation, the incentive to do something is high. Low, sub-3% rates will likely be here forever, other than some brief pops, for two main reasons: too much money to invest in too few safe assets, and globally indebted governments like ours literally can't afford the payments on the debt if the rates rise to 'normal' levels.

The Fed is going to orchestrate a system to keep the economy and government functioning and that is likely going to require managing how much cash and bond investors can lose relative to inflation. Don't hate the Fed, though - they are merely picking up after our government, which won't or can't close the gap between spending and tax revenues. It is almost preposterous that the Fed may have to raise rates soon, probably crushing stocks and real estate, all to fight inflation that the government can clamp down on by raising taxes and/or cutting spending. Sadly, the fiscal response would only help our debt situation while the Fed's fix of raising rates will only worsen it by raising the government's borrowing costs.

But while low rates can and should rationalize higher asset prices, they won't prevent downside risk as panic takes over or guarantee higher returns going forward.

The main difference between now and the early 2000s Dow 36,000 book era isn't stock valuations, which are almost equally absurd as they were in 2000 (and in many cases more so). It is the lack of a safe 5% choice.

Imagine stocks double from here in the coming few years, and we get a dividend yield of below 1% across the market (currently only 1.3%, roughly where we were in 2000) and P/E ratios go to 44 from around 22 now. Or double again and get to basically Japan 1989 valuation levels. At some point, you won't beat even the negative inflation adjusted returns of safer bonds or cash over time. The same is true of real estate - there is a point, say when the rental yield doesn't even cover property taxes and maintenance, that upside is more or less limited. There is a reason Warren Buffett currently is sitting on a record $150 billion in cash..

The Japan stock market is still about 25% under the highs of over 30 years ago. When you get into bubble territory, the only way to not lose money in the longer run is if the underlying fundamentals - earnings with stocks, rents with real estate - grow and catch up to your overvaluation. Unlike Japan, we've remained a positive GDP growth country (but only in the sub-3% range annualized since the 2000 bubble) and tech earnings have caught up to the old NASDAQ price level, eventually.

The question is, can we grow the fundamentals fast enough again when we are already running massive budget deficits with little room to add more, under-tax and overspend as if in a recession, are hitting inflation levels the Fed will eventually crush, and are probably going to face rising taxes in the future? We've got other population issues that will be an increasing drag, as they have been in Europe and Japan.

For those looking too hard for investments to get away from zero, please check out "Series I Savings Bonds" directly from the U.S. Treasury's 1990s retro website. They are sold with zero yield with an inflation adjustment, so if inflation is 5% you get a 5% return in the form of the bond's value going up - a gain that can be deferred for 30 years.

These directly sold non-market-traded bonds can be superior to the inflation-adjusted bonds we already own in our portfolios and client accounts (and are now selling), which already adjusted up in value as investors' fear of future inflation grows (leaving room for a drop if we get falling inflation fears). Direct I bonds don't sell at a premium (other than a no-coupon besides an inflation adjustment - itself a sign of high demand). You will still need inflation to be higher than, say, 2% to beat regular non-inflation bonds, so while they may have no downside they can underperform other low-return investments. What you don't risk is "losing" 5% to 10% if inflation comes down fast, as can be the case in TIPS if you buy now and sell when investors aren't as fearful about future inflation.

The direct-bought bonds are limited to $10k per person per year or larger investors would be snapping them all up. It is a gift in this market. Yes, they can be sold when there are better deals in other safe assets (which may be never) or stocks (likely). The current interest rate is 7.12%, but it will drop when the government gets around to stamping out inflation, or if inflation just proves to be transitory as we are told. All those gold investors who are down for the year during our highest inflation year in decades shouldn't be jealous of cryptocurrencies, but zero-risk, zero-fee, or zero-commission inflation-adjusting bonds that guarantee to pay you the rate of inflation. They don't advertise them on TV, of course.

It is also worth noting that stock markets tend to go down soon after a rise in inflation, not so much because rising prices destroy economies at relatively low levels of inflation, but because the actions taken to fight inflation sink asset prices. This is why the transitory theory better prove right - if inflation goes away "naturally," with no major Fed action, we are far more likely to avoid another market slide.

Stock Funds1mo %
Vanguard Energy (VDE)11.21%
[Benchmark] Vanguard 500 Index (VFINX)7.00%
Vanguard Utilities (VPU)6.01%
Homestead Value Fund (HOVLX)5.82%
Vanguard Value Index (VTV)5.44%
Vanguard FTSE Europe (VGK)5.03%
Vanguard Small-Cap Value (VBR)4.56%
VanEck Vectors Pharma. (PPH)3.69%
Vanguard FTSE Developed Mkts. (VEA)3.23%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.15%
Franklin FTSE Germany (FLGR)3.12%
Franklin FTSE China (FLCH)2.43%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.11%
Invesco CurrencyShares Euro (FXE)-0.31%
Franklin FTSE South Korea (FLKR)-1.52%
ProShares Decline of Retail (EMTY)-5.65%
Franklin FTSE Brazil (FLBR)-9.17%
ProShares UltraShort QQQ (QID)-14.69%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)3.52%
Vanguard Long-Term Bond Index ETF (BLV)1.72%
Vanguard S/T Infl. Protect. (VTIP)0.70%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.03%
iShares JP Morgan Em. Bond (LEMB)-1.18%