The strong recovery in bonds and stocks from the lows of 2022 that continued into January came to an abrupt halt in February. Bonds are now essentially flat for the year while the stock market gains, which almost broke 10%, have been cut in half. The hardest-hit stocks of last year have rebounded far more than 10% from their lows (but are still down far more than the broader market). This reversal of stocks and bonds puts a balanced portfolio up around 2–3% for the year. International stocks are holding up a bit better, though emerging markets were hit hard in February. With rates going back up, the U.S. dollar is recovering losses from the past few months, also weighing on our international funds.
The weight of double-digit drops in Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) as well as 3–7% hits to our bond funds pulled our portfolios down more than the benchmarks in February, leaving us barely above water for the year, while the S&P 500 is up 3.56% in 2023.
Our only winners were short funds last month. Of the hundred-plus fund categories available to investors, only short-term bonds and bank loans were up at all—and both under 1%. Some of our losses were after big run-ups in January, notably Vanguard Communication ETF (VOX), which was down 4.07% yet still up over 10% for the year. Our recently added LeatherBack L/S Alt. Yld. (LBAY) dove 5.73% and is down about as much for the year. The fund is somewhat similar to a fund we use in our managed accounts, Vanguard Market Neutral, and owns stocks while having short positions in some of the market's formerly highest flyers—questionable recent IPOs and trendy innovation stocks. These formerly hot stocks were down sharply last year but rebounded into the deep double digits in January, leading this fund to fall. The king of all future stocks, Tesla, has almost doubled since the bottom last year.
Recently added NightShares 2000 (NIWM) was down 5.88% for the month and is slated for removal from our portfolios. Unfortunately, this historical anomaly-based ETF hasn't come close to living up to the promise of an interesting risk–reward tradeoff by avoiding stocks during the day (the fund owns stock futures overnight). Most historical patterns end after investors catch on—but this one was early enough to seem workable.
Rounding out our weakness was the Euro slipping back down, sending Invesco CurrencyShares Euro (FXE) down 2.64%. Meanwhile, cryptocurrencies are in their own half-baked resurgence after the crash last year, sending Proshares Short Bitcoin (BITI) down 1.14% after a brutal January for this inverse Bitcoin fund. Surprisingly, the trouble keeps coming to companies in the crypto or digital currency area, from regulatory to more recently a run on a crypto-friendly bank. The Crypto faithful—or rather deluded—seem happy just hoarding the digital tokens and don't care if an actual business other than gambling comes to fruition after around a decade. This is not how the Internet and smartphone went down, disproving the theory that crypto is the next major innovation to take off and change lives and make a fortune “for the brave,” to misquote a recent commercial for crypto gambling by a famous actor.
It looked like the worst was behind the bond market, but rates have gone back up to roughly 4% for 10-year government bonds, sending mortgages back up toward 7%. While inflation is slowing (so far), it is definitely not falling fast enough to encourage the Federal Reserve to stop raising rates, much less lower rates as was the expectation a few months ago, which can risk inflation rising anew. T bills now pay around 5%, which is looking more attractive by the day. The main downside is that rates will go back down during the next mini-crisis. This will leave you at near 0% for who knows how long while stocks take off, keeping investors in the same uncomfortable position of early 2022—earn low yields or buy pricy stocks.
The economy is still hot. More of a surprise, the housing market hasn’t adjusted to reflect the new reality of near 7% mortgages. More of a mystery is how the commercial office market is hanging in there with the twin problems of rising rates and low occupancy in our new work-from-home reality.
High-risk debt hasn't tanked any harder than investment-grade bonds since the expectation is that the economy will remain strong enough (and inflation high enough) to allow the issuers of all the questionable debt to remain solvent. While the actual path to rising defaults could be slow, the realization defaults that could be coming can hit prices fast.
Nobody knows where inflation is going here or abroad. There is a “good news is bad news” game going on: strong economic data can hurt the market as investors speculate that it will lead the Fed to send rates too high, causing a financial calamity. The worst fund category last month was precious metals, down over 12% after a strong start to the year. Typically this area does best during rising inflation fears and falls as these fears subside. The worst thing for gold is a hawkish Fed raising rates to 6%, while a gold bug that holds no-yield gold then is faced with deflation caused by the Fed's high rates.
We're eventually going to find out if this inflation boomlet is a blip just like the years after WW2, in which case raising rates high is a bad move, or if it is the beginning of a new era of '70s-style economic stagnation and stubbornly high inflation.
Raising rates is a dangerous game because it takes time for the economy to slow down, and—by then—asset prices may have crashed. The safer move would be to raise taxes and cut spending and run a budget surplus, similar to post-WW2, to get the excess money out of the system. Today is more like the early '80s—there is no political will to remove money from voters’ hands, so we have to see what Fed rate hikes do.
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The strong recovery in bonds and stocks from the lows of 2022 that continued into January came to an abrupt halt in February. Bonds are now essentially flat for the year while the stock market gains, which almost broke 10%, have been cut in half. The hardest-hit stocks of last year have rebounded far more than 10% from their lows (but are still down far more than the broader market). This reversal of stocks and bonds puts a balanced portfolio up around 2–3% for the year. International stocks are holding up a bit better, though emerging markets were hit hard in February. With rates going back up, the U.S. dollar is recovering losses from the past few months, also weighing on our international funds.
Our Conservative portfolio declined 3.74% while our Aggressive portfolio declined 4.13%. Benchmark Vanguard funds for February 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 2.44%; Vanguard Total Bond Index (VBMFX), down 2.55%; Vanguard Developed Mkts Index (VTMGX), down 3.40%; Vanguard Emerging Mkts Index (VEIEX), down 6.27%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.20%.
The weight of double-digit drops in Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) as well as 3–7% hits to our bond funds pulled our portfolios down more than the benchmarks in February, leaving us barely above water for the year, while the S&P 500 is up 3.56% in 2023.
Our only winners were short funds last month. Of the hundred-plus fund categories available to investors, only short-term bonds and bank loans were up at all—and both under 1%. Some of our losses were after big run-ups in January, notably Vanguard Communication ETF (VOX), which was down 4.07% yet still up over 10% for the year. Our recently added LeatherBack L/S Alt. Yld. (LBAY) dove 5.73% and is down about as much for the year. The fund is somewhat similar to a fund we use in our managed accounts, Vanguard Market Neutral, and owns stocks while having short positions in some of the market's formerly highest flyers—questionable recent IPOs and trendy innovation stocks. These formerly hot stocks were down sharply last year but rebounded into the deep double digits in January, leading this fund to fall. The king of all future stocks, Tesla, has almost doubled since the bottom last year.
Recently added NightShares 2000 (NIWM) was down 5.88% for the month and is slated for removal from our portfolios. Unfortunately, this historical anomaly-based ETF hasn't come close to living up to the promise of an interesting risk–reward tradeoff by avoiding stocks during the day (the fund owns stock futures overnight). Most historical patterns end after investors catch on—but this one was early enough to seem workable.
Rounding out our weakness was the Euro slipping back down, sending Invesco CurrencyShares Euro (FXE) down 2.64%. Meanwhile, cryptocurrencies are in their own half-baked resurgence after the crash last year, sending Proshares Short Bitcoin (BITI) down 1.14% after a brutal January for this inverse Bitcoin fund. Surprisingly, the trouble keeps coming to companies in the crypto or digital currency area, from regulatory to more recently a run on a crypto-friendly bank. The Crypto faithful—or rather deluded—seem happy just hoarding the digital tokens and don't care if an actual business other than gambling comes to fruition after around a decade. This is not how the Internet and smartphone went down, disproving the theory that crypto is the next major innovation to take off and change lives and make a fortune “for the brave,” to misquote a recent commercial for crypto gambling by a famous actor.
It looked like the worst was behind the bond market, but rates have gone back up to roughly 4% for 10-year government bonds, sending mortgages back up toward 7%. While inflation is slowing (so far), it is definitely not falling fast enough to encourage the Federal Reserve to stop raising rates, much less lower rates as was the expectation a few months ago, which can risk inflation rising anew. T bills now pay around 5%, which is looking more attractive by the day. The main downside is that rates will go back down during the next mini-crisis. This will leave you at near 0% for who knows how long while stocks take off, keeping investors in the same uncomfortable position of early 2022—earn low yields or buy pricy stocks.
The economy is still hot. More of a surprise, the housing market hasn’t adjusted to reflect the new reality of near 7% mortgages. More of a mystery is how the commercial office market is hanging in there with the twin problems of rising rates and low occupancy in our new work-from-home reality.
High-risk debt hasn't tanked any harder than investment-grade bonds since the expectation is that the economy will remain strong enough (and inflation high enough) to allow the issuers of all the questionable debt to remain solvent. While the actual path to rising defaults could be slow, the realization defaults that could be coming can hit prices fast.
Nobody knows where inflation is going here or abroad. There is a “good news is bad news” game going on: strong economic data can hurt the market as investors speculate that it will lead the Fed to send rates too high, causing a financial calamity. The worst fund category last month was precious metals, down over 12% after a strong start to the year. Typically this area does best during rising inflation fears and falls as these fears subside. The worst thing for gold is a hawkish Fed raising rates to 6%, while a gold bug that holds no-yield gold then is faced with deflation caused by the Fed's high rates.
We're eventually going to find out if this inflation boomlet is a blip just like the years after WW2, in which case raising rates high is a bad move, or if it is the beginning of a new era of '70s-style economic stagnation and stubbornly high inflation.
Raising rates is a dangerous game because it takes time for the economy to slow down, and—by then—asset prices may have crashed. The safer move would be to raise taxes and cut spending and run a budget surplus, similar to post-WW2, to get the excess money out of the system. Today is more like the early '80s—there is no political will to remove money from voters’ hands, so we have to see what Fed rate hikes do.