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May 2022 Performance Review

June 5, 2022

A late-month rebound in stocks stopped May from being as bad as April. This reversal is probably because interest rates took a break from the dramatic rise this year, a rise that has taken most bond funds down 5%—20% in value. Foreign stocks did a little better last month than the tech-heavy US market, which has been under significant pressure since this market turned south at the beginning of this year. May was a good month for our portfolios, especially relative to US markets.

Our Conservative portfolio gained 1.50%, and our Aggressive portfolio gained 2.12%. Benchmark Vanguard funds for May 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 0.18%; Vanguard Total Bond Index (VBMFX), up 0.58%; Vanguard Developed Mkts Index (VTMGX), up 1.73%; Vanguard Emerging Mkts Index (VEIEX), up 0.62%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.69%.

We're still down almost 10% in our Conservative portfolio YTD, which is a rough year compared to the 12.78% hit to the stock market. Our Aggressive portfolio is down a more respectable 5.22% for the year.

Much of the froth in the stock market around supposedly innovative stocks of the future is now gone, although many still need to go to zero like in the 2000—2002 washout. The most trendy growth stocks are now mostly down 50%—90% from highs. The Nasdaq was recently down shy of 30% year to date before the recent rebound (still down over 20% YTD). For the record, the Nasdaq was down around 40% in 2000—the year the tech bubble popped—though, from the peak in March 2000, the Nasdaq fell around 50% (and 75% top to bottom in 2002). Last month, technology-oriented funds were down about 3% and 28% for the year.

In general, stock valuations globally aren't that bad. This will likely only be a good entry point if interest rates stick around these levels and we avoid a recession. Safe bonds are now reasonably priced at roughly 3% yields. Although 3% sounds like a terrible deal with near 10% inflation, the days of almost guaranteed positive returns adjusting for inflation in safe assets are gone. One way or the other, inflation will return to sub 3%, and bonds should more or less break even with inflation. We remind you to buy your yearly allotment ($10k max per person) of Series I Savings Bonds direct from the US Treasury.

If inflation doesn't start to fall, global central banks will have to keep punishing the market—not just the stock market but the housing market. In theory, if governments raised taxes and cut spending, we'd get a balance in supply and demand, but in practice the Fed is probably going to have to raise rates higher than inflated asset prices can handle.

We're close to moving back out on the yield curve to longer-term bonds—into the fire. The next leg down in bonds will likely be high-yield junk bonds—the authentic proof a recession is around the corner. We may also increase our foreign stock allocation, though there will be no immunity from a recession by investing abroad.

All of our holdings except Vanguard Extended Duration Treasury (EDV), which was down 4.03% last month (and down 21% since added back to portfolios in February), beat the S&P 500 in May (except our short QQQ fund), which reflects how much of this slide is tied to mega-cap US growth stocks. Our top performer last month was the recently volatile Franklin FTSE Brazil (FLBR), up 7.15%. In theory, this fund will be a winner from high global commodity prices that need to come from places that are not Russia, but there is risk in any emerging market for a worldwide recession that lowers all prices. This fund would be a good holding for a soft landing economically, meaning one where central banks can ease us off high inflation without a deep recession.

Our second-best holding was Franklin FTSE Germany (FLGR), up 5.16%, rebounding off a significant drop this year. With increasing talk of cutting way back on Russian energy, Germany is in a precarious position economically now. The one that got away, energy funds are still delivering this year as oil goes ever higher on a still-hot economy with supply issues. Energy funds are the top area this year, up 45% for the year and 13% last month. Too bad we cut back a few months ago. The worst place is digital asset-oriented funds, down around 50%. Too bad they didn't make a crypto token backed by oil instead of ones supported by... another crypto (and now down 99.9%).

Other big losers for the month include real estate funds, down around 5% as rising rates and a slowing economy place risks on this area beyond making the yield less attractive. It is still unclear what is going to happen to commercial real estate if this hybrid work structure sticks because, long term, it will create a glut in office space that won't be easy to fix with lower rates, unlike the last crash in commercial real estate.

Our third best holding Vanguard Utilities (VPU), up 4.51%, is due for a cut as investors swinging out of risky growth stocks have landed on safe income stocks, and the relative value is falling fast here.

The next shoe to drop, if there is one, will be high-yield bonds, notably floating-rate debt that investors feel is safe because the yields reset with short-term rates. The trouble in this area, which we do not have direct exposure to as in floating rate or bank loan funds, is shaky as companies won't be able to make these payments if rates rise too far, especially if we get a weak economy and high short-term rates. The good news is the loan you made to me now pays 7%, not 4%. The bad news is I can't afford 7%. Defaults will go up, way up.

There is a broader issue here with our margin loan economy. With low rates below inflation and far below historical price increases in real estate and stocks, it made sense to borrow against your stocks to buy real estate or just have money to spend. Why pay tax selling stocks that should go up 5%—15% a year forever when you can borrow against this portfolio at 3%, tax-deductible? Stock-backed loans are how many tech billionaires avoid tax and finance lavish lifestyles for a long time. Recently this financial engineering has been marketed to the rich but not the island-owning rich by banks. Such securities-backed loans are everywhere on balance sheets, on top of the near trillion dollars in ordinary stock margin loans, a record.

The banking system seems secure because today's real estate loans are much safer. Low down payment adjustable rate "loser" loans to those lying about their income (No Income, No Job NINJA loans) are more or less gone from the system. Now the homes are backed by solid folks sitting on millions in stocks.

This is all fine and dandy until stocks fall 50% or more. We may never expose this weak link in the economic chain, but if we do, it could be as bad for real estate and stocks as 2008. It has been quite some time, 1929 to be exact, since excessive stock leverage has led to economic and market problems. Banks don't remember, but customers with high credit scores swimming in assets can default quickly as subprime borrowers if conditions turn very dark.

In the meantime, the Fed isn't going to be there to support a crash unless inflation cools off. The market, for the first time in 30+ years, is flying without an insurance policy.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)7.15%
Franklin FTSE Germany (FLGR)5.16%
Vanguard Utilities (VPU)4.51%
ProShares Decline of Retail (EMTY)4.28%
Vanguard FTSE Europe (VGK)2.41%
Homestead Value Fund (HOVLX)2.41%
Vanguard Value Index (VTV)2.41%
Franklin FTSE China (FLCH)2.25%
VanEck Vectors Pharma. (PPH)2.17%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.73%
Franklin FTSE Japan ETF (FLJP)1.72%
Vanguard FTSE Developed Mkts. (VEA)1.65%
Invesco CurrencyShares Euro (FXE)1.64%
Franklin FTSE South Korea (FLKR)1.42%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.62%
[Benchmark] Vanguard 500 Index (VFINX)0.18%
ProShares UltraShort QQQ (QID)-1.15%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)0.91%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.58%
iShares JP Morgan Em. Bond (LEMB)0.48%
Vanguard Long-Term Bond Index ETF (BLV)0.23%
Vanguard Extended Duration Treasury (EDV)-4.03%