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April 2022 Performance Review

May 5, 2022

Ouch. Global markets are not in the mood to fight inflation, and the market reaction to the Fed press conference of May 4th only highlights the growing fear of the world of waning global monetary stimulus. Stocks and bonds were down sharply across the board in April as inflation shows no signs of abating without action — the kind that slams the economy and markets. The real story isn't the near-double-digit hit to stocks, but the near-double-digit hit to bonds. These fears are rational. Inflatable assets like commodities, real estate, and stocks often do very badly when inflation heads back down. Bonds do badly when inflation isn't in check. If both are down, then the assumption is that the higher rates in the bond market are going to "work" in cooling inflation.

Our Conservative portfolio declined 5.72%, and our Aggressive portfolio declined 5.54%. Benchmark Vanguard funds for April 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 8.72%; Vanguard Total Bond Index (VBMFX), down 3.85%; Vanguard Developed Mkts Index (VTMGX), down 6.55%; Vanguard Emerging Mkts Index (VEIEX), down 5.55%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 7.43%.

In hindsight, when we cut back on inflation-adjusted bonds (which we went into last year when rates and inflation were low), we should have just parked half the portfolio in cash instead of mortgage bonds. Like everyone, we were scared of nearing zero on cash for years waiting for higher rates or lower stock prices. Well, higher rates came fast — about as fast as the 1994 and late 1999 bond mini crash. Long-term government bonds were down about 9% in April — more than stocks — and are down around 20% for the year as of now. The good news for investors is now you can earn 3% safely. Over time, this is better than if rates remained 1%.

Before you get too scared, keep in mind the bond market isn't going to fall 50% like stocks can from here. Some ultra-long-term zero coupon government bonds may fall briefly. If bonds fall much harder, it will be brief, at least for government bonds. In such a crisis, the Fed would switch to money creation and bond buying again (and hasn't even started selling off the bonds purchased with new money during the COVID crash).

This is a leveraged world with sky-high asset prices based on low rates. The U.S. government can't afford our debt at 7%, and neither can anybody else. The "good" news for the government is they just inflated away 10% of the debt or maybe $2 trillion. Without almost guaranteed inflation of over 5% a year, nobody can afford to buy a high-priced home with a 7% mortgage. Sure we've had 10% mortgages "in the past," but then homes were priced at 2 times average incomes; today it is more like 4 times. In many hot real estate markets, that number is 10 times.

Current bond yields are actually not a bad deal in the long run as we will likely, hopefully, return to sub-3% inflation, and in general low default risk bonds probably won't pay more than inflation for long periods of time ever again — as we've noted here before.

Some commodity funds were up a little last month, but 99% of fund categories were down. Commodity funds won't do well if inflation heads back down and we get a recession, but they will do well if inflation remains above 4% with the economy remaining hot. The hardest hit areas included foreign stocks and growth stocks. Tech stocks are in a bear market, and technology category funds are down close to 25% for the year. As noted before, this doesn't even capture the full-on 2000 grade crash in stocks of the future or so-called innovation investments. These are now down 50% to 90%. Many will go to zero.

Our inverse Nasdaq fund is finally paying off with a 45% gain YTD. This has partially offset big losses in bonds and stocks, notably in our remaining long-term bonds and foreign stocks. Our China fund Franklin FTSE China (FLCH) is down 19.46% for the year. As proof of the pain in bonds, our Conservative portfolio is down 10.95% for the year, while our Aggressive portfolio is down just 5.54%, as opposed to the near 13% drop in the Vanguard 500 fund and a whopping 13.81% year to date drop in Vanguard Star Fund (VGSTX), which highlights the hard hit to bonds and foreign stocks this year. That's right, diversifying into bonds and foreign stocks actually increased downside in 2022, so far. Our strongest areas include VanEck Vectors Pharma. (PPH), down just 2.25% for the month and up 1.31% for the year, followed by utilities, which were basically flat for the year after Vanguard Utilities (VPU) slid 4.38% for the month.

The Federal Reserve Chairman press conference from April 4 made little sense. Initially, there was a massive spike in stocks, which (so far) abruptly reversed on April 5 during one of the wildest two-day sessions in a long time.

The Fed is in a tough spot. They probably feel that this inflation is sort of phony as it results from distortions in supply and demand and that if they react to aggressively it will cause a depression, yet they can't keep saying "transitory" and doing nothing. Imagine if the government decreed three-day weekends for workers for a year and sent bonus checks to all workers every few months. We'd have inflation. Should the Fed raise rates and cause a recession to fix it? Isn't the fix either get used to higher prices as supply and demand adjust or go back to work 5 days a week and stop sending stimulus checks (or deferring loan payments)?

The gist of the message from the first in-person Fed press conference since COVID was that the legislators aren't to blame even though they are the ones who handed out checks and encouraged working less during shutdowns. The high inflation is all the Fed's world — and the Fed will deal with it. No more Mr. Nice Rate Guy — inflation must be brought down to save the little guy. We don't work for Goldman Sachs! This strong message was followed up with fairly weak action and a near guarantee that shorter term rates won't go up that fast or that much — because we sure don't want to cause a recession to fight the worst inflation in 40 years.

The wild card to higher rates is the increasingly bizarre government support of stretched consumers and borrowers. There is no telling what a pandering state or federal government will do if mortgage rates hit 6% on a 30-year fixed rate mortgage — already well over 5%, which is a big move up from around 3% or lower just a few months ago. Perhaps we'll get checks in the mail to subsidize bigger mortgage payments for new home buyers — why not? We got oil released from the Strategic Petroleum Reserve and essentially handouts to car owners in CA and gas tax breaks in Republican states because gas prices went up. The consumer must always be coddled! Higher prices and rates won't work in slowing demand if we get subsidized for high prices.

Bottom line, in the short run, rates may go up more to counter the Fed's lazy response to inflation caused by Congress. Bond holders are getting nervous. This will start hitting stocks harder than bonds, though we could see a bond fund rush to the exists (again). Ultimately we'll slide into a recession if rates get too high, and bonds will go back up with rates down as inflation fears morph into deflation fears (again).

If the federal government isn't going to address inflation caused by supply and demand imbalances, the Fed needs to raise short-term rates faster than planned to prevent long-term rates from going up too fast — basically reassuring bond investors that inflation is going away so you can safely buy a 3% government bond. Losing the long end means 6% mortgages and recession.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)29.91%
ProShares Decline of Retail (EMTY)0.99%
VanEck Vectors Pharma. (PPH)-2.25%
Vanguard Utilities (VPU)-4.38%
Invesco CurrencyShares Euro (FXE)-4.72%
Vanguard Value Index (VTV)-4.79%
Franklin FTSE China (FLCH)-5.17%
Homestead Value Fund (HOVLX)-5.51%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-5.55%
Vanguard FTSE Europe (VGK)-6.25%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-6.55%
Franklin FTSE South Korea (FLKR)-6.62%
Vanguard FTSE Developed Mkts. (VEA)-6.79%
Franklin FTSE Japan ETF (FLJP)-7.86%
Franklin FTSE Germany (FLGR)-8.01%
[Benchmark] Vanguard 500 Index (VFINX)-8.72%
Franklin FTSE Brazil (FLBR)-13.21%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-3.59%
[Benchmark] Vanguard Total Bond Index (VBMFX)-3.85%
iShares JP Morgan Em. Bond (LEMB)-4.71%
Vanguard Long-Term Bond Index ETF (BLV)-9.49%
Vanguard Extended Duration Treasury (EDV)-12.57%