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August 2023 Performance Review

September 13, 2023

With interest rates on the rise once again, stocks and bonds globally were down. The economy is not slipping into a recession so far, at least not in the USA. However, rates are expected to remain high due to escalating costs in energy and housing. Notably, only short-term bond funds exhibited growth last month, with almost all fund categories sinking. Some riskier bond funds were the exception, benefiting from a robust economy that supports higher default risk bonds.

Our Conservative portfolio declined by 2.66%, while our Aggressive portfolio saw a decrease of 3.14%. Benchmark Vanguard funds for August 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 1.59%; Vanguard Total Bond Index (VBMFX), down 0.58%; Vanguard Developed Mkts Index (VTMGX), down 4.05%; Vanguard Emerging Mkts Index (VEIEX), down 5.69%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, experienced a 2.57% decline.

It appears we have navigated through the majority of the inflation spurred by excessive money creation during Covid, combined with demand and supply issues after months of lockdown. The lingering effects are primarily due to a burgeoning real estate bubble and the government’s inability to curb the budget deficit — even during prosperous times. This has resulted in a continuous stimulus program while the Federal Reserve attempts to dampen inflation and slow the economy.

Increasing rates are making it expensive for the government to manage its substantial debt. The options to navigate this predicament seem limited to tolerating above 2% inflation targets or raising taxes. Although our debt-to-GDP ratio has been steadily climbing since the early 2000s, low interest rates mitigated the impact on debt payments relative to GDP. Unfortunately, this era is nearing its end; with the mounting interest rates, the financial burden on government revenues is set to become increasingly difficult to bear.

Historically, we have countered recessions with significant deficit spending, as seen in the responses to the 2000 recession (peak 3.3% deficit to GDP) and the Great Recession (peaking just under 10%). The COVID-19 pandemic escalated this to an almost 15% deficit-to-GDP budget. Alarmingly, we observe a persistent trend of growing deficits, now exacerbated by the spiraling interest charges on national debt and inflation-indexed government spending. Under current tax regulations and automatic spending plans, we are drifting towards a deficit exceeding 11%, a gap that appears insurmountable, even without the onset of a new crisis.

Surprisingly, the irrational housing market remains unfazed by the mortgage rate surpassing 7% and home prices eclipsing their 2006 peak when adjusted for inflation. Theoretically, home values should plummet to equalize monthly payments with the higher mortgage rate, but a stalemate between reluctant sellers and priced-out buyers has led to an unstable yet high market plateau.

Earlier this year, the banking sector faced a mini-crisis, a situation that might recur if rates continue to ascend. Remarkably, banks that rectified their mistakes following the mid-2000 housing bubble are now finding their focus on prime fixed-rate loans to be problematic. Some banks that faltered this year might have weathered the storm with a more diversified portfolio that included adjustable-rate subprime mortgages. Consequently, banks wouldn't be constrained to a fixed yield of 3% on their investments while having to pay some depositors rates approaching 5%.

Current investor apprehensions are primarily directed towards foreign markets, mainly China, standing on the precipice of a obubble collapse. Our Franklin FTSE China (FLCH) bore the brunt of this, depreciating by 9.46% last month, while most emerging markets collectively fell over 5%. Most of the debt in China is in the private sector and local governments. The relatively low debt government can theoretically bail out the economy by essentially taking on the debt, probably with increased state control. Although the Chinese government retains substantial borrowing capacity, contrasting with many major economies, it’s ambiguous how the US government plans to mitigate the impending economic crisis, with our borrowing capacity nearing its limit.

Long-term interest rates zoomed back up to the highs of 2022, sending some of our bond funds down for the year. The Vanguard Extended Duration Treasury (EDV), the most sensitive to rate alterations, fell by 4.67% last month. The resurgence in the US dollar’s value led to a 3.25% dip for iShares JP Morgan Em. Bond (LEMB) last month, even in a month where higher credit risk bond funds experienced a slight uptick.

The temptation is to run from bonds and foreign markets and chase hotter US growth markets, fueled by AI optimism. This will likely lead to more risk and lower returns in the coming years.

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%