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July 2023 Performance Review

August 5, 2023

The stock market continued the fairly steady gains that started last fall and is now just around 5% below the all-time high of late 2021. This latest move up is in spite of interest rates drifting higher, leaving the bond market down far more than stocks since rates rose – dropping about 15% recently. The stock market is like a fighter in a movie, taking severe punishment in the form of rising rates and saying, "Is that all ya got?" to commentators asking "what is keeping him standing?" before a big comeback.

Our Conservative portfolio gained 1.23%, and our Aggressive portfolio gained 2.09%. Benchmark Vanguard funds for July 2023 were as follows: Vanguard 500 Index Fund (VFINX), up 3.21%; Vanguard Total Bond Index (VBMFX), down 0.06%; Vanguard Developed Mkts Index (VTMGX), up 3.17%; Vanguard Emerging Mkts Index (VEIEX), up 5.91%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, gained 2.64%.

Developing and smaller foreign markets picked up, and we saw a big 11.18% jump in Franklin FTSE China (FLCH) with a 6.77% move in Franklin FTSE South Korea (FLKR). For the US market, large-cap tech has been the primary driver this year, taking Vanguard Communication ETF (VOX) up 6.21%. Almost all of our drag last month was longer-term bonds, with a 3.93% hit to Vanguard Extended Duration Treasury (EDV) and a 2.22% drop in Vangaurd L/T Treasury (VGLT) as markets are growing fearful of US government debt and don’t think inflation is going to ease anytime soon. Essentially every fund category was up last month except for government bonds.

Risky bonds did well, notably our iShares JP Morgan Em. Bond (LEMB) stake, up 1.49% as investors' fear of debt defaults dropped to near historic lows. Energy and financial stock funds were the top two performers last month, reversing year-to-date losses in both fund categories.

The spinach to this Popeye stock market is the growing feeling that the economy can handle the significantly higher rates without a recession — unlike basically every other time the Fed raised rates. The so-called soft landing is now the expected outcome. Add in an Artificial Intelligence boom lifting many larger tech stocks, and we're off to the races.

Inflation is coming down, and the economy is strong, but the biggest drivers of higher prices are heading up again – housing, labor, and energy. The boom in prices is partially the result of low supply. The production of almost everything is lower than a few years ago – oil, homes, cars. There are many reasons for this; productivity has been so-so for a few years now, OPEC has cut production to keep prices high, and businesses from airlines to autos don’t want to flood the market and drive prices down.

Nowhere is the supply shortage distortion more of an issue than homes. Sellers don’t want to sell and lose their 3% mortgage. Buyers need lower prices or lower rates. We’re in a low-volume bubble. By most measures of real estate value for the country (like price to income or price to rent), we’re in a real estate bubble as overpriced as 2006 – and that ended poorly. The only real difference is buyers aren’t quite as leveraged because the no-money-down era is mostly gone.

It would be very difficult to get inflation down to the target of 2% without some sort of break in home prices. The high prices and general unaffordability of a new home purchase are lifting rents as more potential buyers can’t afford to buy.

But the market isn’t worried about the collapse of a second real estate bubble. More recently, the market – at least the bond market – is starting to worry about the US Government's increasingly precarious financial situation.

Fitch, one of the three big bond ratings companies, lowered the US government's debt rating from AAA to AA+, similar to what S&P did in 2011. Only Moody's still holds the US government as highly as say, Norway or Germany. While the actual risk of default is realistically zero, the issues raised are real. The only thing going well for the government's balance sheet right now is inflation reducing the amount of debt we have relative to our inflating GDP – we’re inflating ourselves out of debt, similar to the post-WW2 experience. This is why bondholders are suffering.

Since the government isn’t capable of cutting spending and raising taxes to right the ship – the Fed has to raise rates to lower inflation, which only makes the problem worse as the economy could drag, reducing tax revenues, while the cost of our existing debt mushrooms. Fitch expects our annual deficit to be over 6% of GDP in 2023 from 3.7% in 2022, which is crazy for a strong economy.

For now, the stock market doesn’t care how the government is going to fix this later, and if they keep using above-target inflation, well, stocks and real estate may do better than bonds once again. Meanwhile, longer term interest rates are approaching 100-year average yields and a big improvement from the near-zero rates globally for much of the post-2000 era when the Fed used low rates to fix things.

Stock Funds 1mo %
Franklin FTSE China (FLCH) 11.18%
Franklin FTSE South Korea (FLKR) 6.77%
Vanguard Communications ETF (VOX) 6.21%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX) 5.91%
Vangaurd All-World Small-Cap (VSS) 4.93%
Proshares Short Bitcoin (BITI) 4.80%
Franklin FTSE Brazil (FLBR) 4.76%
Homestead Value Fund (HOVLX) 3.93%
Vanguard Value Index (VTV) 3.45%
[Benchmark] Vanguard 500 Index (VFINX) 3.21%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX) 3.17%
Vanguard FTSE Developed Mkts. (VEA) 3.14%
Vanguard FTSE Europe (VGK) 2.90%
Franklin FTSE Japan ETF (FLJP) 2.66%
VanEck Vectors Pharma. (PPH) 2.61%
Franklin FTSE Germany (FLGR) 2.52%
LeatherBack L/S Alt. Yld. (LBAY) 2.18%
NightShares 2000 (NIWM) 2.02%
Invesco CurrencyShares Euro (FXE) 0.92%
Proshares Short High Yld (SJB) -0.76%
ProShares Decline of Retail (EMTY) -2.25%
ProShares UltraShort QQQ (QID) -7.03%
UltraShort Bloom. Crude Oil (SCO) -24.01%
Bond Funds 1mo %
iShares JP Morgan Em. Bond (LEMB) 1.49%
[Benchmark] Vanguard Total Bond Index (VBMFX) -0.06%
Vanguard Long-Term Bond Index ETF (BLV) -1.14%
Vangaurd L/T Treasury (VGLT) -2.22%
Vanguard Extended Duration Treasury (EDV) -3.93%