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November 2018 Performance Review

December 6, 2018

November was a rocky month for stocks and bonds, but it ultimately ended on a positive note. Our portfolios did well compared to the Vanguard STAR fund, which has recently had more downside than our portfolios and potentially less upside as investors shift their portfolio strategies.

Our Conservative portfolio gained 1.04% in November, and our Aggressive portfolio gained 2.15%. Benchmark Vanguard funds for November 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 2.03%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.53%; Vanguard Developed Markets Index Fund (VTMGX) up 0.39%; Vanguard Emerging Markets Stock Index (VEIEX) up 4.45%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.30%.

Just a few weeks ago, fast-rising interest rates risked dragging the housing market (and possibly the entire economy) into a mild recession. Now falling interest rates are indicating a possible recession on the horizon. There seems to be a very small band of acceptable interest rates.

The initial take by professional investors when rates went up was that they were going up for the right reasons, which means the economy is booming, demand to borrow is high, and inflation is picking up. This narrative quickly changed when stocks started to drop, and a prevailing view emerged that significantly higher rates would cause a recession for a variety of reasons, including a too-strong dollar, real estate market issues, and the great unknown of trillions in corporate debt.

When interest rates drifted back down, things improved for stocks. In recent weeks, the benchmark 10-year government bond rate drifted up towards 3.25% on several days, which equates to roughly a 5% 30-year fixed rate mortgage; each time this happened, stocks slipped hard and then recovered as rates drifted back down.

Now we are facing a more disturbing situation since the benchmark rate has sunk below 3%: rates are going down for the wrong reasons, which means a recession could be coming, and low inflation and demand for safe investments will push rates right back down to the levels we saw a year or more ago.

This drop in rates has been good for bonds and yield-oriented investments and helped our portfolios—we are effectively recession-ready relative to other portfolios. Our top three stock funds were all value- and yield-oriented, and they beat the S&P 500: Homestead Value (HOVLX), Vanguard Utilities (VPU), and Vanguard Value (VTV) went up 4.42%, 3.92%, and 3.27%, respectively. These three were only bested by our short on oil PowerShares DB Crude Oil Dble Short (DTO) and iShares MSCI BRIC Index (BKF) riding a reversal in emerging markets in general and stocks in India in particular, for a 6.48% gain.

Larger-cap value funds were the best performers in U.S. stock funds last month. Emerging market stocks and bonds had a nice run after a terrible year. These areas could see a move up if investors start to look somewhere else for risk besides U.S. tech.

The rising economic fear has also been bad for oil, which slid more in recent weeks than even after the 2008 commodity bubble burst. The trigger may have been increased output by Saudi Arabia and Russia in anticipation of Iran sanctions that never came in earnest. Fears of a recession and leveraged gamblers in the oil market unwinding their positions didn't help either. We saw a 45% gain in November shorting oil with 2x leverage in PowerShares DB Crude Oil Dble Short (DTO) after an 18% gain in October. Don't be too excited since the fund is still down slightly for the year because oil rose substantially during the economic optimism of recent months, setting up shorting oil as a good hedge against a recession. Shorting small-cap stocks and biotech stocks lost money in November as riskier stocks recovered after the slide in October.

Stock Funds1mo %
PowerShares DB Crude Oil Dble Short (DTO)45.61%
iShares MSCI BRIC Index (BKF)6.48%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)4.45%
Homestead Value (HOVLX)4.42%
Vanguard Utilities (VPU)3.92%
Vanguard Value (VTV)3.27%
[Benchmark] Vanguard 500 Index (VFINX)2.03%
iShares MSCI Italy Capped (EWI)1.36%
iShares Global Telecom ETF (IXP)1.22%
Vanguard Europe Pacific ETF (VEA)0.51%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.39%
Gold Short (DZZ)-0.33%
Vanguard European ETF (VGK)-0.68%
Vanguard Telecom Services ETF (VOX)-0.74%
Proshares Ultrashort Russel2000 (TWM)-3.77%
Proshares Ultrashort NASDAQ Biotech (BIS)-10.13%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)2.18%
Vanguard Mortgage-Backed Securities (VMBS)0.90%
SPDR Barclays Intl. Treasury (BWX)0.85%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.53%
Vanguard Long-Term Bond Index ETF (BLV)0.40%
Dodge & Cox Global Bond Fund (DODLX)0.19%

October 2018 Performance Review

November 4, 2018

Ouch. The good times ended in October and rather suddenly at that. There are many straws out there, and it's impossible to know which one broke the market's back but break it did.

The best explanation, which is one part voodoo and one part real economics, was that the market has been up for so long that investors were looking for signs that the music was going to stop. The sign was rising interest rates leading to fears that the global economy and real estate market couldn't handle higher rates. This in turn led to worry that tech stocks have risen so far so fast that the downside is exceeding the upside.

In October, our Conservative portfolio declined 3.52%. Our Aggressive portfolio declined 3.11%. Benchmark Vanguard funds for October 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 6.85%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.73%; Vanguard Developed Markets Index Fund (VTMGX) down 8.49%; Vanguard Emerging Markets Stock Index (VEIEX) down 7.58%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 5.71%.

Even with our interest-rate-sensitive portfolios with significant foreign exposure (a performance drag), we fell significantly less than the S&P 500. More notable is that the global total portfolio benchmark that we also aim to beat over time, the Vanguard STAR fund, was down 5.71%, almost as much as the S&P 500 and quite a bit for a diversified global portfolio that is only 60% stocks. We're trying to deliver a better risk/reward tradeoff than this balanced fund (not an easy task given this is a great low-fee total portfolio fund, but we aim high) but have been lagging it recently on the way up. As you can see, such upside performance often comes at a price—Vanguard STAR was taking quite a bit more downside risk than we were.

One reason balanced portfolios fell in October is that all categories fell. That has become the new problem with building portfolios: there is nowhere to hide when the drops come but low-return cash. Diversification doesn't really work anymore.

The best-performing fund categories in October were precious metals, utilities, and Latin America. Not coincidently, precious metals funds and Latin American funds have some of our highest category ratings on MAXfunds: 91 and 97, respectively. We're still short gold because we don't believe it has any long-term investment merit, and our limited stake in Latin American stocks in our iShares MSCI BRIC Index (BKF) fund was offset by losses in the RIC part—Russia, China, India—of BRIC (though the fund fell less than emerging markets in general).

Other areas of relative strength include value stocks in general, an area we are focusing more on after the big run in growth and tech this past decade or so. But our only traditional stock fund that posted a gain was Vanguard Utilities (VPU), up 1.17%—even Vanguard Value (VTV) was down 4.35%.

Homestead Value (HOVLX) dropped 9.03% despite being a value fund because it's somewhat of a tech value fund now. The fund's holdings are probably more economically sensitive than many other value funds, and the fears of rates hurting the economy hit this fund hard.

All our bond funds where down, but long-term bonds fell the hardest with Vanguard Extended Duration Treasury (EDV) down the most at 4.61%. Long-term rates shouldn't go up much from here (at least not quickly without risking much more downside to stocks). You'd rather be in long-term bonds with the moderate loss you will take than the stock alternatives if rates climb quickly.

The shining stars of October were our three short funds, all up high double digits: PowerShares DB Crude Oil Dble Short (DTO) up 18.6%, Proshares Ultrashort Russel2000 (TWM) up 24.56% and Proshares Ultrashort NASDAQ Biotech (BIS) up 33.42%. These funds, which can slowly go to nothing over time as markets long term go up, can be useful in a crash scenario. We should have rebalanced into a short tech fund because our short stake was so small after dwindling in value in the portfolio from losses in the bull market as to have minimal upside performance impact. That said, we did beat the balanced portfolios out there and these funds are a good part of the reason our "riskier' aggressive portfolio actually fell by less than our short-fund-free conservative portfolio.

Stock Funds1mo %
Proshares Ultrashort NASDAQ Biotech (BIS)33.42%
Proshares Ultrashort Russel2000 (TWM)24.56%
PowerShares DB Crude Oil Dble Short (DTO)18.60%
Vanguard Utilities (VPU)1.17%
Gold Short (DZZ)-3.47%
Vanguard Value (VTV)-4.35%
Vanguard Telecom Services ETF (VOX)-6.20%
iShares MSCI BRIC Index (BKF)-6.32%
iShares Global Telecom ETF (IXP)-6.79%
[Benchmark] Vanguard 500 Index (VFINX)-6.85%
Vanguard European ETF (VGK)-7.53%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-7.58%
Vanguard Europe Pacific ETF (VEA)-8.26%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-8.49%
Homestead Value (HOVLX)-9.03%
iShares MSCI Italy Capped (EWI)-9.44%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-0.57%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.73%
SPDR Barclays Intl. Treasury (BWX)-1.65%
Dodge & Cox Global Bond Fund (DODLX)-1.77%
Vanguard Long-Term Bond Index ETF (BLV)-3.22%
Vanguard Extended Duration Treasury (EDV)-4.61%

September 2018 Performance Review

October 7, 2018

In early October the unemployment rate dropped to its lowest level since 1969. This is sending interest rates back up to 'normal' levels. The difference this time is the stock market is now sinking along with bonds.

In September, larger market value stocks crept up slightly in the U.S. while smaller-cap stocks fell. Abroad was a similar story — big companies in major economies were up marginally while riskier emerging market stocks continued to sink.

Bonds where weak across the board with bigger drops in longer-term interest rate sensitive bonds as rates continued to move up on good economic news and general optimism. The backdrop of a strong economy helped junk bonds and higher risk debt score fractional gains as defaults seemed less likely. All in, our benchmark global balanced fund by Vanguard was down fractionally, as was our Aggressive model portfolio. The recent changes to our Conservative model portfolio helped it eke out a positive month.

Our Conservative portfolio gained 0.18% in September. Our Aggressive portfolio declined 0.37%. Benchmark Vanguard funds for September 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 0.55%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.54%; Vanguard Developed Markets Index Fund (VTMGX) up 0.73%; Vanguard Emerging Markets Stock Index (VEIEX) down 1.31%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.18%.

The strong economy is pushing interest rates up, which so far has been good for U.S. stocks and higher risk bonds. Foreign stocks and bonds have been weak as the brunt of the trade war seems to be hitting markets that export to us.

But there also could be another reason that rates are going up that is not just the backdrop of a growing economy with rising inflation. In fact, inflation isn't rising that fast — nor are wages, which would warrant higher interest rates across the board. No, what we may be seeing is just too much borrowing.

Our government is now increasing borrowing in a strong economy that normally would lead to a slowly shrinking yearly deficit (as was the case in recent years and is the case with most foreign governments). Corporations are borrowing more too. While a handful of tech companies are swimming in trillions in cash, most are still borrowing, and a good chunk have credit ratings that are either junk grade or just marginally investment grade — they're basically subprime borrowers. Lucky for them bond fund managers and increasingly index funds keep loading up on borderline junk debt just like investors did with low grade mortgage debt in the mid 2000s.

These companies seem to be using the increased cash flow from tax cuts to buy back more stock and not pay off debt, which is good for stock prices, but not bonds. In fact, the tax cuts make debt less valuable in financial engineering because the tax deduction of interest rates becomes less valuable. The problem is twofold — CEOs are compensated (highly) when stock prices rise. Paying off debt doesn't increase the value of their stock options like buying back stock does.

In the movie Scarface a young climber up the criminal ladder played by Al Pacino is given sage advice by a more conservative successful drug dealer: Don't get high of your own supply. Today many companies are high off of their own supplies of bonds. Buying other companies, buying back stock etc.

Low interest rates and debt-hungry investors make it all work, at least for now. But many of these marginal businesses are in no position to handle higher interest rates. They need to stop buying stock at high prices and start paying down debt because refinancing at 2-3 percentage points higher isn't going to work — companies that need to leverage are already having problems. GE's stock price is not far off from the 2009 levels when the world economy was in perhaps the worst debt crisis in history.

Stocks may look reasonably valued compared to past bubbles when you look at the dividend yield (1.96% on the S&P 500) but when you consider that some of these companies need to cut back on the dividend sooner rather than later and start paying off debt, and that payout ratios (how much of earnings are going out as dividends) are already higher than in 2000, and that earnings are somewhat juiced by low interest rate borrowing — a spread that can quickly decline with rising borrowing costs — the market is almost as expensive as the biggest valuation bubble in history, early 2000.

The days of rising rates hurting bonds while stocks go up with the economy and earnings likely ended in early October as the market blew through 3% on the 10-year government bond. Nobody knows how real estate is going to do with 6% or even 7% thirty-year mortgages, but we're already seeing indicators that the 5% level just hit this week is causing issues. Nobody knows what happens to Ford when customers can't finance a new truck at low rates. It is completely possible 1/3 of the S&P 500's earnings could away at a 5% 10-year bond rate a level.

More disturbing is how our government is going to finance the $20+ trillion in debt at 5% — or $1 trillion a year in interest costs alone. We currently shelling out $500 billion a year in interest costs. As recently as 2012 that number was $360 billion. We're now paying 2.5% on the debt pile, which (lucky for us) is barely above inflation. Yes, it takes quite some time to change this rate given the vast portfolio of maturities and debt type, but it is going up.

Best case: if interests keep rising (and they may not because the demand to borrow at higher rates could plunge) we'll have to raise taxes and cut spending rapidly (like Greece) and some leveraged companies (like GE) will go bankrupt. You don't want to know the worst case.

The longer corporations and our Government use excess debt to drive GDP growth and stock prices during these good times, the harder the next fall is going to be. The President — no stranger to debt problems — knows this which is why he, according to inside the White House stories, wanted to raise the top income bracket to help pay for the corporate tax cut. Republicans talked him down because Republicans don't do that. If interest rates continue to climb somebody is going to be paying more taxes soon. Maybe that's the real reason we're adding tariffs to imports.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)4.68%
iShares Global Telecom ETF (IXP)3.51%
iShares MSCI Italy Capped (EWI)2.07%
Gold Short (DZZ)1.69%
Homestead Value (HOVLX)1.14%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)0.73%
[Benchmark] Vanguard 500 Index (VFINX)0.55%
Vanguard Telecom Services ETF (VOX)0.52%
Vanguard Europe Pacific ETF (VEA)0.35%
Proshares Ultrashort NASDAQ Biotech (BIS)0.19%
Vanguard Value (VTV)-0.04%
Vanguard European ETF (VGK)-0.32%
Vanguard Utilities (VPU)-0.38%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.31%
iShares MSCI BRIC Index (BKF)-1.32%
PowerShares DB Crude Oil Dble Short (DTO)-8.31%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)0.75%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.54%
Vanguard Mortgage-Backed Securities (VMBS)-0.60%
SPDR Barclays Intl. Treasury (BWX)-0.74%
Vanguard Long-Term Bond Index ETF (BLV)-1.27%
Vanguard Extended Duration Treasury (EDV)-4.11%

August 2018 Performance Review

September 6, 2018

U.S. stocks were hot again in August while foreign stocks were very much not. At this stage it looks like the U.S. is winning the trade war, but some of this global stock divergence could be due to frightened international investors moving funds into the U.S. from suddenly scary looking emerging market stocks and bonds. There are now at least three economies in some form of economic chaos — Venezuela, Argentina, and Turkey.

Our Conservative portfolio fell 0.15% in August. Our Aggressive portfolio declined 0.77%. Benchmark Vanguard funds for August 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 3.25%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.52%; Vanguard Developed Markets Index Fund (VTMGX) down 1.91%; Vanguard Emerging Markets Stock Index (VEIEX) down 3.55%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.17%.

The small gains for our value/income focused U.S. stock funds (and even smaller gains from U.S. bond funds) were more than swallowed up by losses in anything foreign last month, stock or bond. The Vanguard STAR fund we aim to beat over time not only has more in stocks (60%) and less interest rate exposure but also has more of the stock allocation in U.S. stocks (40% U.S. / 20% non-U.S. Our net stock exposure in our Aggressive portfolio in real money now is about 28% US to 22% foreign In Conservative we are just under 20% US / 16% foreign).

Notably weak recently have been Italian stocks; sending our iShares MSCI Italy Capped (EWI) position down 9.27% for the month. Investors want to avoid being invested in the next crisis economy abroad. Politically questionable and leveraged Italy sitting on a rocky economic foundation seems a likely trouble spot.

The hottest areas in the U.S. were growth stocks, notably smaller cap growth stocks, up 7.65% for the month and capping a 32%+ twelve-month streak. The five-year leader remains larger-cap growth, the category where all the tech giants live.

The coldest August performers were foreign stocks with Latin American stocks sliding just shy of 10% — double the next worst performer China. This was not good for our iShares MSCI BRIC Index (BKF) position last month. Latin America is really the only stock fund category down over the last five years.

In sectors, technology was again the top gainer up 6.11% for the month and the one-year leader at 28%. Some famous managers that underperformed much of the last decade by being too heavy in foreign and value stocks are finding new focus in tech and healthcare This is likely a mistake. Such performance chasing will be a drag over the next ten years.

This recently intensifying performance gap in foreign vs domestic stocks really started around the last bear market in 2007. Some of the gap can be chalked up to currency changes as the dollar's long slide in the early 2000s reversed course over the last decade or so, but a lot more of it has to do with investors putting too much money abroad in the early to mid-2000s. They bid up international stock prices too high relative to U.S. stocks and we're still working it off. The gap is also widened by the sheer domination in technology companies in the United States and the relatively strong U.S. economy.

That said, China has big powerful tech companies and even more economic growth and the main China ETF (FXI) price is still down over 40% from the bubble peaks of 2007 (though with dividends an investor is only down about 25% over a decade later). The fund asset level is down around half from the near $10 billion peak and the fund is sitting on a couple of billion in realized losses because the average investor lost money in China and most other hot then not funds. Come back and look at U.S. biotech ETFs in ten year's you will see a similar pattern.

Looking just at ETF cash flows this year (where most of the hot money goes now) investors moved money out of U.S. stocks during the brief slide early this year and into foreign stocks — which turned out to be exactly the wrong move as U.S. stocks rebounded and foreign stocks dropped.

Even without a bear market the performance pendulum should swing back to foreign stocks as it did after the late 1990s performance run by U.S. growth stocks.

Looking back over the last 9+ years of this historic bull market with no drops over 20% (the definition of a bear market) along the way, our main performance problem was not sticking with our U.S. growth focus and a high stock allocation well after the last crash — these trends tend to last longer than you expect. There was too much money still going abroad over the last few years for foreign to be the bargain of the early 2000 era.

Ideally, we'd get another full-blown emerging market crash. This ultimately could lead to the sort of pricing where you can get back into the high-single low-double digit stock returns for taking on higher risk. Today there is plenty of downside risk in the U.S. market and just mid-single digit upside.

Stock Funds1mo %
Gold Short (DZZ)4.99%
[Benchmark] Vanguard 500 Index (VFINX)3.25%
Vanguard Telecom Services ETF (VOX)2.83%
Homestead Value (HOVLX)2.13%
Vanguard Value (VTV)1.90%
Vanguard Utilities (VPU)1.15%
iShares Global Telecom ETF (IXP)-0.10%
Vanguard Europe Pacific ETF (VEA)-1.73%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.91%
Vanguard European ETF (VGK)-2.83%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.55%
iShares MSCI BRIC Index (BKF)-4.77%
PowerShares DB Crude Oil Dble Short (DTO)-5.56%
Proshares Ultrashort Russel2000 (TWM)-8.11%
Proshares Ultrashort NASDAQ Biotech (BIS)-9.20%
iShares MSCI Italy Capped (EWI)-9.27%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)1.65%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.52%
Vanguard Mortgage-Backed Securities (VMBS)0.50%
Vanguard Long-Term Bond Index ETF (BLV)0.48%
SPDR Barclays Intl. Treasury (BWX)-0.62%
Dodge & Cox Global Bond Fund (DODLX)-1.20%

July 2018 Performance Review

August 5, 2018

The stock market continued its rebound in July. We're still underperforming for the year, with too much interest rate exposure and too little stock exposure, but for the month we were basically in line with the benchmark Vanguard total portfolio fund while still taking less risk in both our portfolios. Our recent changes to our Conservative portfolio seem to be helping.

Our Conservative portfolio gained 2.04%. Our Aggressive portfolio gained 1.87%. Benchmark Vanguard fund performances for July 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 3.71%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.03%; Vanguard Developed Markets Index Fund (VTMGX) up 2.32%; Vanguard Emerging Markets Stock Index (VEIEX) up 3.18%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.12%.

In general, larger value stocks did best in July and smaller growth stocks the worst — though all U.S. broad categories were in positive territory. The only real weakness was Chinese stocks, as the growing trade war seems to be impacting their stock and currency markets. (Commodities were also down.)

Value stocks took the lead after a long stretch of growth stock outperformance. This boosted Homestead Value (HOVLX) to our top performer's spot for the month, with a 6.84% rise. Shorting gold and oil through PowerShares DB Crude Oil Dble Short (DTO) and Gold Short (DZZ) delivered gains of 6.77% and 4.79% respectively. After a long run up, oil seemed to hit a ceiling, and commodities in general were weak. Our biggest loser was in shorting biotech stocks with leverage, which resulted in a double-digit loss for Proshares Ultrashort NASDAQ Biotech (BIS).

Stocks sensitive to interest rates did well in July, though bonds were mixed to down. Our new holding Dodge & Cox Global Bond Fund (DODLX) had a solid month — up 1.68% — but our high interest rate risk zero-coupon bond fund Vanguard Extended Duration Treasury (EDV) was down 2.21% as interest rates climbed.

iShares Global Telecom ETF (IXP), our new pick for our Conservative portfolio, had a good month. It was up 3.53%, in sharp contrast to our old telecom pick, Vanguard Telecom Services ETF (VOX).

Vanguard Telecom Services ETF (VOX) was up only 0.30% in July because the index makers decided telecom and communication indexes are too boring and needed some Facebook (FB) magic, because why own boring stocks like Verizon (VZ)?

Of course, the index experts didn't cook up this idea years ago when social media stocks were new to the market. No, they waited until Facebook was one of the most valuable stocks in history before adding the stock to the dull benchmark index, and just days before Facebook collapsed 20% in ONE DAY as various questionable behaviors began to scare investors.

You know what stocks don't fall 20% in one day? Verizon and other large telecom companies. This is a warning to anyone over-relying on index funds these days (ourselves included).

Not to belabor the point, but one of the long-term rationales for indexing or passive management over actively managed funds has been control over the holdings and no style drift, which means a fund going from, say, a value slant to a growth slant. I can't imagine a bigger drift in style than cutting back on old phone companies for Facebook stock. At the end of the day, these indexes are actively managed. They chase performance and trends just as much as actively managed funds.

Questions hanging over the market for the short and long term include: 1) rising tariffs with China, which has so far been almost a non-event for U.S. stocks ; 2) the continuing investigations into Trump and Russia; 3) rising interest rates and the impact we're starting to see in real estate, and; 4) increasing government debt without a recession, resulting from tax cuts and spending increases.

Lots escalating — including stocks, for now…

Stock Funds1mo %
Homestead Value (HOVLX)6.84%
PowerShares DB Crude Oil Dble Short (DTO)6.77%
Gold Short (DZZ)4.79%
Vanguard Value (VTV)4.65%
[Benchmark] Vanguard 500 Index (VFINX)3.71%
iShares Global Telecom ETF (IXP)3.53%
Vanguard European ETF (VGK)3.40%
iShares MSCI Italy Capped (EWI)3.39%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)3.18%
Vanguard Utilities (VPU)2.56%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.32%
Vanguard Europe Pacific ETF (VEA)2.28%
iShares MSCI BRIC Index (BKF)2.04%
Vanguard Telecom Services ETF (VOX)0.30%
Proshares Ultrashort Russel2000 (TWM)-3.27%
Proshares Ultrashort NASDAQ Biotech (BIS)-11.76%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)1.68%
Vanguard Long-Term Bond Index ETF (BLV)0.41%
SPDR Barclays Intl. Treasury (BWX)0.29%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.03%
Vanguard Mortgage-Backed Securities (VMBS)-0.05%
Vanguard Extended Duration Treasury (EDV)-2.21%

June 2018 Performance Review & Trade Announcement

July 3, 2018

June was a respectable month for U.S. stocks (though you wouldn't know it from our portfolios…) but a down month for bonds and foreign stocks. Emerging market stocks were the big loser among foreign stocks — down 4.44% — primarily on trade war fears .

Our Conservative portfolio declined 0.52% in June. Our Aggressive portfolio fell 0.84%. Benchmark Vanguard funds for June 2018 were a­s follows: Vanguard 500 Index Fund (VFINX) up 1.22%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.33%; Vanguard Developed Markets Index Fund (VTMGX) down 0.83%; Vanguard Emerging Markets Stock Index (VEIEX) down 4.44%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.12%.

U.S. growth stocks were hot while value-oriented stocks lagged again. In an odd turn interest rate sensitive funds with higher yields were top sectors even though value stocks in general lagged.

Real estate funds jumped 4.6% (though still down for the year) while utilities and communication funds were up 3.15% and 2.85% respectively. Other than our short on gold (which had a good month) only our holdings in these three areas beat the S&P 500 last month, with Vanguard Telecom Services ETF (VOX) and Vanguard Utilities (VPU) scoring 2.83% and 1.53% returns respectively.

These gains could be because recent weakness in these sectors created bargains, but could also be because interest rates stopped rising (by and large) with a strange 3% ceiling forming across the treasury yield curve at most maturities. This is relevant to our positions in telecom funds which we are in the process of changing to global telecom funds because U.S telecom indices are evolving to include tech stocks like Facebook and Google.

At the end of June we made some trades in the Conservative portfolio largely because one of our holdings, ETRACS 1xMonthly Short Alerian MLP (MLPS), was liquidated for lack of investor interest.

The trade brought two new holdings to the Conservative portfolio: iShares Global Telecom ETF (IXP) and Dodge & Cox Global Bond Fund (DODLX).

iShares Global Telecom ETF (IXP) is a new global telecom fund, an index fund based on a global telecom index. The yield is attractive if interest rates don't rise significantly and will offer extra benefits over a domestic telecom fund should our dollar fall.

Dodge & Cox Global Bond Fund (DODLX) was added because it's becoming a good time to consider low fee active management in general as indexing takes over the investing landscape. In addition, our previous no-transaction fee ETF in this area is no longer NTF at TD Ameritrade (the brokerage platform we use for our real money model portfolios and client accounts). This is a global fund so there is significant US exposure. We went with a larger allocation here (30%) but are getting some currency oomph from global telecom stocks as well.

The very low fee choice that is NTF iShares Core International Aggregate Bond ET (IAGG) for us at TD Ameritrade is hedged to the dollar which defeats the main purpose of owning non-US dollar denominated bonds which is diversification and protection from a slide in the U.S. dollar. Otherwise, unless you go with a higher risk emerging markets bond fund you wind up with 1% yielding government bonds. We can do better than that in yields from our own debtor nation which is paying near 3% as our deficit widens (while other major economies are seeing shrinking debt to GDP levels in this strong global economy).

With this trade we removed 4 holdings (not including the fund company liquidation and cash settlement in ETRACS 1xMonthly Short Alerian MLP (MLPS) which would make it 5):

It was time to cut back on junk bonds, which have been doing well, and our pick in this area, Artisan High Income Fund (ARTFX), was in the top 10% of this category for much of the fund's existence (including this year). At $3 billion in assets the top percentile returns and 5-star rating are no longer likely given the high 1% fees.

Artisan Global Equity Fund Investor Class (ARTHX) has been a solid performer and is still smallish but is too expensive at 1.40%

SPDR Barclays Intl. Treasury (BWX) is no longer transaction-fee free at TD (where we keep our real-money portfolios), and it's too expensive for a non-NTF fund. Recent weakness could get you a tax loss. In general active management with low fees should do slightly better than indexing in coming years.

We're trying to get away from higher credit risk yield though may come back to this on weakness. The iShares Mortgage Real Estate ETF (REM) mortgage REIT ETF, which owns mortgages purchased with borrowed money, has been a decent performer for us with a roughly 41% return (with dividends reinvested) since January 7th 2016.

We also rebalanced some holdings to slightly different allocations just to make the trade more cost efficient: Vanguard Mortgage-Backed Securities (VMBS) from 14% to 12%, Vanguard Long-Term Bond Index ETF (BLV) from 20% to 19% and Homestead Value (HOVLX) from 6% to 7%. These ETFs (but not HOVLX) also stopped being NTF for us at TD so small trades don't make sense at this time and we may eventually move out of some of these for this reason.

Alternates to consider here:

For iShares Global Telecom ETF (IXP): Because domestic telecom indexes are getting tech stock updates, this category is about to get noticeably higher risk and lower yield. You might try Fidelity Select Telecommunications Portfolio Fidelity Select Telecommunications Portfolio (FSTCX) and you can stick with Vanguard Telecom Services ETF (VOX) if need be but don't also own tech funds. The ETFs in this area are heading in the direction of T. Rowe Price Comm & Tech Investor (PRMTX) which already went tech years ago and has big stakes in Amazon (AMZN) so you won't be worse off than in Vanguard Telecom Services ETF (VOX) after the changes. In general we’re not in telecom to increase tech exposure – rather to avoid it - which you already get plenty of in regular stock indexes and just about everything these days.

For DODLX you can continue to use SPDR Barclays Intl. Treasury (BWX) or the cheaper iShares International Treasury Bond ETF (IGOV). Those who want more risk and higher yield could consider iShares J.P. Morgan EM Local Currency Bond ETF (LEMB) which is NTF at TD Ameritrade. In active management, if you can avoid the sales load one of the classes of Strategic Global Bond Fund (MAWIX) can work. AB FlexFee International Bond Advisor (FFIYX) is cheap and new and small and the flex fee is interesting (at 0.20% for now until the fund performs well against a benchmark) but the dollar hedging is unappealing right now PIMCO Foreign Bond (Unhedged) (PFUIX) if you can avoid the sales commission or load and get a cheaper class no more than 0.75% a year.

Stock Funds1mo %
Gold Short (DZZ)7.94%
Vanguard Telecom Services ETF (VOX)2.83%
Vanguard Utilities (VPU)1.53%
[Benchmark] Vanguard 500 Index (VFINX)1.22%
Vanguard Value (VTV)0.21%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-0.83%
Vanguard European ETF (VGK)-1.22%
Homestead Value (HOVLX)-1.34%
Proshares Ultrashort Russel2000 (TWM)-1.40%
Vanguard Europe Pacific ETF (VEA)-1.64%
iShares MSCI Italy Capped (EWI)-1.88%
Proshares Ultrashort NASDAQ Biotech (BIS)-2.99%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.44%
iShares MSCI BRIC Index (BKF)-4.91%
PowerShares DB Crude Oil Dble Short (DTO)-19.41%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)1.35%
Vanguard Mortgage-Backed Securities (VMBS)0.08%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.33%
Vanguard Long-Term Bond Index ETF (BLV)-0.58%
SPDR Barclays Intl. Treasury (BWX)-1.02%

May 2018 Performance Review

June 2, 2018

The market was rolling along just fine in May with the volatility from earlier in the year seemingly easing and good economic data slowly pushing up stocks and interest rates (and inflation).

Then, at the end of the month, Italy returned as a potentially destabilizing force to foreign investing, sending Italian stocks (which we own directly through iShares MSCI Italy Capped (EWI)) down sharply and taking the euro and most other foreign markets down with it.

Treasury bonds had one of their best days in years at the end of the month as money flowed into the U.S. (which, ironically, is following similar policies being discussed by rising political parties in Italy — raising spending and cutting taxes and backing away from global trade arrangements). With losses in our foreign currency dominated bonds in SPDR Barclays Intl. Treasury SPDR Barclays Intl. Treasury (BWX) and European stock ETFs, plus our shorts on suddenly hot small cap and biotech stocks, we couldn't come close to the U.S. stock and bond heavy benchmarks.

Our Conservative portfolio gained 0.01% in May. Our Aggressive portfolio fell 1.22%. Benchmark Vanguard funds for May 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 2.39%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.61%; Vanguard Developed Markets Index Fund (VTMGX) down 1.60%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.86%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.23%.

Investors have been favoring foreign markets up until recent weeks. This could have been a warning sign this slide was coming but is also largely the result of everybody benchmarking and indexing these days. In other words, unlike in 2000 investors aren't favoring foreign stocks so much as rebalancing. Foreign stocks have been underperforming for years, which is why investors still have 2.5x times more money in domestic stocks.

Even though interest rates slipped and our longer-term bond holdings like Vanguard Extended Duration Treasury (EDV) and Vanguard Long-Term Bond Index ETF (BLV) posted returns of 2.33% and 1.28% respectively in May, we had too many negatives in foreign funds and shorts — including a 2.03% drop in foreign bonds owned through SPDR Barclays Intl. Treasury SPDR Barclays Intl. Treasury (BWX) as the euro slid along with Italian bonds.

The hottest areas in the market last month were growth funds — notably small cap growth which was up 6.68% for the month.

Emerging markets were hit hard, especially Latin American funds which were down by double digits in May.

Technology funds were the strongest sector, up over 6% last month, and have the highest five year returns now of any fund category at just under 20% annualized returns.

Currently out-of-favor communication sector funds, which where the worst sector last month, should be considered for the next five years. The dividend yield will make a decent return compared to alternatives, in all likelihood.

We're sitting on a solid economy domestically and now globally. The trouble for investors going forward is two-fold. First, things looked great in 2000 as well. Second, people seem hell bent on messing up a good thing and pulling defeat from the jaws of victory.

We're risking our longer term financial solvency and increasing interest rates needlessly in the shorter run to increase spending and cut taxes into an already solid economy that doesn't need stimulus. Then we are pursuing risky and vaguely defined trade wars to fix wrongs in global trade. Abroad there seems to be rising nationalism with Brexit and now Italy to separate from global economic policy. Little was broke in post WWII global economics except a brief period of high inflation with low growth and a dangerous real estate bubble, but there seems to be a rising desire to fix it anyway.

Stock Funds1mo %
iShares Mortgage REIT (REM)2.89%
Gold Short (DZZ)2.81%
[Benchmark] Vanguard 500 Index (VFINX)2.39%
Homestead Value Fund (HOVLX)0.98%
Artisan Global Equity (ARTHX)0.93%
PowerShares DB Crude Oil Dble Short (DTO)0.74%
Vanguard Value ETF (VTV)0.61%
Vanguard Utilities (VPU)-0.31%
iShares MSCI BRIC Index (BKF)-1.09%
Vanguard Europe Pacific ETF (VEA)-1.43%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.60%
Vanguard European ETF (VGK)-2.42%
Vanguard Telecom Serv ETF (VOX)-2.63%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.86%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-4.57%
Proshares Ultrashort NASDAQ Biotech (BIS)-9.27%
iShares MSCI Italy Capped (EWI)-9.77%
Proshares Ultrashort Russel2000 (TWM)-11.09%
Vanguard Extended Duration Treasury (EDV)2.33%
Vanguard Long-Term Bond Index ETF (BLV)1.28%
Vanguard Mortgage-Backed Securities (VMBS)0.74%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.61%
Artisan High Income Fund (ARTFX)0.42%
SPDR Barclays Intl. Treasury (BWX)-2.03%

April 2018 Performance Review

May 5, 2018

April was not a particularly good month for stocks or bonds but once again the modest monthly change disguised the intramonth and often intraday volatility that is becoming more common in the stock market. Foreign non-emerging market stocks performed well. Riskier debt moved up slightly but longer-term, investment grade bonds and foreign bonds slid as the dollar reversed a steady decline. Our government debt now pays substantially higher interest rates than other major economies, and it's likely attracting inflows of cash which could push our currency back up in value.

Our slant towards longer-term bonds didn't help in April compared to benchmarks. Our Conservative portfolio declined 0.88%. Our Aggressive portfolio fell 0.56%. Benchmark Vanguard funds for April 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 0.37%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.83%; Vanguard Developed Markets Index Fund (VTMGX) up 1.55%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.03%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.07%.

Much of the volatility in stocks appears to be related to ten-year government bonds getting to around the 3% level. The worry is that rates will blow through that threshold and shoot up to 4% and beyond with rising inflation fears. The already strong economy is now getting fanned by increased spending and tax cuts. Effectively we've got a small stimulus package kicking in when unemployment is already below 4%. Nobody really knows what will happen to the economy if borrowing costs rise significantly but if interest rates rise in anticipation of higher inflation it could cause problems — particularly for the government than needs to rollover trillions in debt at higher interest rates.

This interest rate focus may be taking away from an issue which is more about growth stocks: are these earnings growth rates and rocketing stock prices sustainable? Or are we near the end of another boom cycle in tech with signs of over-indulgence everywhere?

A more value and yield-oriented portfolio could beat a more growth and risk-oriented portfolio in coming years, which would be a near-reversal of the last decade or so. We may still see gains in growth, but the risk-vs-return is becoming unfavorable in the types of stocks that rely more on earnings growth to rationalize higher prices.

We're getting close to year-2000 levels (when value was where you wanted to be, not growth) and farther away from 2008 (when growth, particularly U.S. growth stocks, was where your portfolio should have tilted). Growth index funds have now beat value index funds by just over 2% a year over the last decade — a sizable difference.

The most surprising action in April was the performance of yield oriented stocks like those in utility and telecom funds. These did well even as the stock market was barely up and while interest rates moved higher. Vanguard Utilities (VPU) climbed 2.47% and Vanguard Telecom Services ETF (VOX) rose 1.36%. This may because these areas have been so weak that they are attracting value investors. In general value stocks are getting attractively priced relative to growth stocks after about a decade of growth beating value by upwards of 2% a year.

Oil continued to move higher even as the U.S. dollar rose, which is typically bad for oil prices. Our oil short fund PowerShares DB Crude Oil Dble Short (DTO) fell 10.65% in April, and this time ETRACS 1xMonthly Short Alerian MLP (MLPS) fell 7.51%, reversing some of the recent gains. While this likely won't happen if the economy remains strong, oil is now priced for a near 50% hit if we get a global slowdown.

Stock Funds1mo %
Proshares Ultrashort NASDAQ Biotech (BIS)4.64%
iShares MSCI Italy Capped (EWI)4.42%
Vanguard European ETF (VGK)2.65%
Vanguard Utilities (VPU)2.47%
Gold Short (DZZ)2.30%
Vanguard Europe Pacific ETF (VEA)1.64%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.55%
Vanguard Telecom Serv ETF (VOX)1.36%
Artisan Global Equity (ARTHX)0.61%
Vanguard Value ETF (VTV)0.42%
[Benchmark] Vanguard 500 Index (VFINX)0.37%
iShares Mortgage REIT (REM)0.28%
Homestead Value Fund (HOVLX)-0.28%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.03%
Proshares Ultrashort Russel2000 (TWM)-2.39%
iShares MSCI BRIC Index (BKF)-2.66%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-7.51%
PowerShares DB Crude Oil Dble Short (DTO)-10.65%
Bond Funds1mo %
Artisan High Income Fund (ARTFX)0.38%
Vanguard Mortgage-Backed Securities (VMBS)-0.49%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.83%
Vanguard Long-Term Bond Index ETF (BLV)-2.04%
Vanguard Extended Duration Treasury (EDV)-2.77%
SPDR Barclays Intl. Treasury (BWX)-2.80%

March 2018 Performance Review

April 4, 2018

The relatively tame overall decline of 2.56% in the S&P 500 in March belies the extreme swings that have occurred in the market lately. In the last two months we've seen a fairly quick 10% drop followed by a very quick recovery and then another collapse just recently. Hot tech stocks actually moved to new highs in the bounce back.

Unlike in February, when interest rate increases hurt returns, we fared better relative to the market in March and are now (slightly) outperforming for the year at a just under 0.50% decline in both portfolios (as opposed to a 0.80% decline in the S&P 500).

Our Conservative portfolio gained 1.34% in March. Our Aggressive portfolio gained 0.20%. Benchmark Vanguard funds for March 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 2.56%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.63%; Vanguard Developed Markets Index Fund (VTMGX) down 0.47%; Vanguard Emerging Markets Stock Index (VEIEX) down 1.19%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.89%.

All balanced and target date fund categories were down in March so it was noteworthy we were up, albeit only slighty, as essentially a global balanced portfolio. But then we have shorts and are positioned more yield-sensitive and are generally less credit-sensitive than most balanced portfolios.

Yield-oriented investments did well in March with gains of 6.46% in iShares Mortgage REIT (REM) and 4.02% in Vanguard Utilities (VPU).

Only two of our non-inverse funds underperformed the S&P500 in March.

Longer term investment grade bonds did the best with Vanguard Extended Duration Treasury (EDV) up 4.11%.

Small cap funds were the only main U.S. fund categories in the green, which caused our inverse small cap ETF to go down in an otherwise bad month for stocks.

The other surprise was losses in our short crude oil fund as oil did well in the down market.

Even weirder: our short MLPs fund ETRACS 1xMonthly Short Alerian MLP (MLPS) did very well with a 6.77% gain. In general after years of small cap value relative underperformance it's time to focus on shorting the outperforming — namely larger cap tech and growth stocks. But this is hardly 2000 when value was much cheaper than growth.

All this downside reducing costs upside — no way around it. That is why recently we were even lagging behind total portfolio benchmarks (not that these low fee Vanguard balanced funds are easy to beat). It's nice to see our downside (thus far) lower than these funds. What's more surprising is how our downside compares to funds that are really trying to control downside with active shorting. These funds generally come with a serious upside drag compared to regular cheap balanced index funds.

Market Neutral funds as a category were down 0.31% for the month while we were up. Long-short credit funds were down 0.33%. Long-Short equity funds were down 1.08%. It would be one thing if these funds all fell a little in a down market but had decent upside in up markets. The five year average annual return on these funds are: 0.87% for Market Neutral, 1.6% for Long-Short Credit, 4.49% for Long-Short equity. Our Conservative 5 year average annual return is 5.98% and our Aggressive is 8.36% (all real money with trading commissions and fund fees) as compared to 13.14% for the S&P 500 Vanguard fund.

We do even better if you include a real bear market, which we haven't even had in the last five years. These other fund categories that use shorting to reduce downside are terrible categories to choose from and an investor would do better to just own a balanced index fund and more cash to reduce downside. The fees are just too high and the ideas on what to short just too lousy.

Stock Funds1mo %
ETRACS 1xMonthly Short Alerian MLP (MLPS)6.77%
iShares Mortgage REIT (REM)6.46%
Vanguard Utilities (VPU)4.02%
iShares MSCI Italy Capped (EWI)1.39%
Proshares Ultrashort NASDAQ Biotech (BIS)1.15%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-0.47%
iShares MSCI BRIC Index (BKF)-0.73%
Gold Short (DZZ)-0.76%
Vanguard Europe Pacific ETF (VEA)-0.76%
Vanguard European ETF (VGK)-0.84%
Artisan Global Equity (ARTHX)-0.88%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.19%
Vanguard Value ETF (VTV)-2.44%
[Benchmark] Vanguard 500 Index (VFINX)-2.56%
Homestead Value Fund (HOVLX)-2.67%
Vanguard Telecom Serv ETF (VOX)-2.86%
Proshares Ultrashort Russel2000 (TWM)-3.08%
PowerShares DB Crude Oil Dble Short (DTO)-9.26%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)4.11%
SPDR Barclays Intl. Treasury (BWX)1.77%
Vanguard Long-Term Bond Index ETF (BLV)1.51%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.63%
Vanguard Mortgage-Backed Securities (VMBS)0.56%
Artisan High Income Fund (ARTFX)0.10%

Februrary 2018 Performance Review

March 2, 2018

The problem with a fast climbing market is that sometimes it falls just as fast. This was the case in 1929, 1987, and 2000. Valuations like P/E ratios are relevant to long-term returns but don't mean much when facing extreme short-term volatility. Investors want to make money during sharp rises but don't want to get caught without a chair when the music stops; they tend to leave quickly and in droves at the first hint of a downturn.

February's dramatic drop was briefly more than 10% and technically qualified as a "correction". Almost immediately after the drop, the market rebounded sharply. Then in early March, on new trade war fears that could also impact prices in America and cause an economic drag, the market dropped anew.

We are now in a pretty volatile market after many months of relative stability. Everything fell in February (including bonds) as future interest rate increases where the major concern. Inflation investments like TIPS, gold, and commodities, perhaps even Bitcoin to some, didn't do well so this narrative is a little suspect. Because our short positions have dwindled in size relative to the portfolio after a long rise in stocks, and our longer--term bond funds were hit almost as hard as stocks, we fell along with the markets. Our combined portfolio returns only did about as well as our total portfolio Vanguard benchmark.

Our Conservative portfolio fell 2.39% in February. Our Aggressive portfolio dropped 3.35%. Benchmark Vanguard funds for February 2018 were as follows: Vanguard 500 Index Fund (VFINX) down 3.70%; Vanguard Total Bond Market Index Fund (VBMFX) down 1.03%; Vanguard Developed Markets Index Fund (VTMGX) fell 5.23%; Vanguard Emerging Markets Stock Index (VEIEX) down 4.73%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, dropped 2.74%.

As discussed last month, this is a bit of a too much of a good thing crash all around — tax cuts into a strong economy sending inflation and interest rates high enough to lead the Federal Reserve to (potentially) over react and raise rates too high, causing a recession and growing debt issues as the government refinances debt at higher rates, all while a tax cut reduces federal revenues.

The best- broad 'style box' category in the U.S. was larger--cap growth funds which fell just 2.6%. The worst was small-cap value category funds — down 4.8% on average. The gap in one year returns between these two categories at the opposite ends of the style box is stark: large-cap growth is up about 24% in the last twelve months while small-cap value is up just 4%. This is the why we were in larger-cap funds and shorting small-cap stocks: because this would have created a nice lower risk return in a low yield environment not tied to rate fluctuations with limited stock market downside as you earn the gap between these two performance streaks. Even with the costs and problems of these inverse funds, a simple portfolio with the S&P 500 ETF and an inverse small-cap fund a year ago would have delivered a positive return of about 6% over the last 12 months with a sub 1% downside in the February slide. An actual large-cap growth ETF and an actual short position in a small-cap value ETF (where you borrow the shares and sell them) could have delivered a higher return with an almost market neutral risk profile — especially just looking at the capital invested in the long position minus any margin fees and borrowing costs.

Riskier bonds and longer-term bonds were both hit in February; down 1%-3% typically. Only cash and very short-term bond funds were near flat. There was really no fund category up for the month with heavy losses in energy funds, down just over 10% for the month. Energy is now the second worst traditional category of funds over the last five years down 7% per year on average (with only precious metals funds down more at over 8% a year on average). The whole dividend value/ foreign stock/real return /commodity focus that was popular in recent years has really underperformed a late 1990s style tech and growth portfolio.

While we were right to be short gold and energy related stocks gold the metal which we short hasn't done as poorly as gold mining stocks which are what makes up most of the precious metals fund category holdings. That plus the costs of shorting often make right calls so to say less profitably than they should be especially over longer periods of time which is why mere avoidance of hot areas is the main goal for most investors — but it is difficult in this index focused world.

Our shorts (unsurprisingly) led the way in February with ETRACS 1xMonthly Short Alerian MLP (MLPS) up just over 10% thanks to a drop in energy and related stocks. Our shorts made up our five best performers this month as would almost be expected in a down month for everything. Shorting gold in theory shouldn't have worked if we really have rising inflation fears but again that story is taking the blame a bit for just a collapse in speculative euphoria.

Our performance problem last month is our longer-term bond funds Vanguard Long-Term Bond Index ETF (BLV) and Vanguard Extended Duration Treasury (EDV) were down between 3.13% and 4.29% respectively last month and our other stock funds mostly underperformed the S&P 500.

We were too value and interest rate oriented in this growth dominated market where tech funds were among the least hurt by the slide down — down just 1% on average after their rebound late in the month. The current most pressing fear continues to be inflation. and tech companies are presumably the most insulated from higher interest rates and inflation. Of course, these presumptions by investors have a way of coming undone rapidly when the money really starts evaporating. You can expect the best performing areas (and hence those that attracted the most money) to fall the hardest regardless of whether they are insulated from the current economic issues.

Stock Funds1mo %
ETRACS 1xMonthly Short Alerian MLP (MLPS)10.49%
Proshares Ultrashort NASDAQ Biotech (BIS)9.48%
Proshares Ultrashort Russel2000 (TWM)7.18%
PowerShares DB Crude Oil Dble Short (DTO)4.92%
Gold Short (DZZ)4.37%
Artisan Global Equity (ARTHX)-3.02%
iShares Mortgage REIT (REM)-3.23%
[Benchmark] Vanguard 500 Index (VFINX)-3.70%
Vanguard Utilities (VPU)-4.11%
Homestead Value (HOVLX)-4.30%
Vanguard Value (VTV)-4.44%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.73%
Vanguard Europe Pacific ETF (VEA)-5.11%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-5.23%
Vanguard Telecom Services ETF (VOX)-5.72%
iShares MSCI Italy Capped (EWI)-6.13%
Vanguard European ETF (VGK)-6.15%
iShares MSCI BRIC Index (BKF)-6.94%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-0.66%
SPDR Barclays Intl. Treasury (BWX)-0.75%
Artisan High Income Fund (ARTFX)-0.93%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.03%
Vanguard Long-Term Bond Index ETF (BLV)-3.13%
Vanguard Extended Duration Treasury (EDV)-4.29%

January 2018 Performance Review

February 3, 2018

This bull market is getting a little long in the tooth.

In January, even with some weakness near the end of the month (a slide that accelerated into February), the S&P 500 was up almost 6%, with dividends. It seems like nothing can go wrong — the economy is heating up and corporate after-tax profits are destined to climb with the recent corporate tax cut.

Our Conservative portfolio gained 0.61% in Januaray. Our Aggressive portfolio was up 2.75%. Benchmark Vanguard funds for January 2018 were as follows: Vanguard 500 Index Fund (VFINX) up 5.71%; Vanguard Total Bond Market Index Fund (VBMFX) down 1.10%; Vanguard Developed Markets Index Fund (VTMGX) up 4.86%; Vanguard Emerging Markets Stock Index (VEIEX) up 8.39%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, gained 3.54%.

Unfortunately just as it it's always darkest before the dawn, things can look their brightest before a fall. Too much of a good thing is the main worry right now. We cut taxes into an already heating up economy which will lead to more inflation which will cause the federal reserve to raise rates higher than they would with no tax cuts. This means higher mortgage and other financing rates — and if those go high enough we could be looking at another recession.

The strongest areas last month were Latin stocks up about 12% (and the only double-digit gaining category in January) followed closely by China and emerging market stocks, both up in the 7%-9% range.

Foreign stocks in general beat U.S. equites and larger-cap growth stocks in the U.S. were the strongest area domestically, up a stunning 7.4% in January. Larger-cap growth stocks have now beat smaller value by a fairly wide margin of about five percentage points a year over the last five years and are no longer the great relative bargain they once were.

The only double-digit performers in the models where iShares MSCI BRIC Index (BKF) and iShares MSCI Italy Capped (EWI), up 12.45% and 10.97% respectively. All other holdings else was more or less on par with the market, except for interest rate sensitive funds like Vanguard Utilities (VPU) and Vanguard Telecom Services ETF (VOX) down 3.13% and up 1.14% respectively.

With all boats rising, shorting anything was a bomb.

On the bond side, junk bonds and foreign unhedged bonds did well as our dollar slid again. Our other bond funds suffered with rising rates.

The problem with the very recent stock slide that isn't fully reflected in January numbers is that interest rates are rising and are sending bonds down as well — in fact the rates started going up before stocks went down. Right now, essentially everything is dropping and even balanced portfolios are taking hits. This means bond funds are falling as are safer yield-oriented stocks like telecom and utilities. That said, we're down less than the indexes and the Vanguard Star fund — which should be expected as we were lagging during this sharp run up.

Stock Funds1mo %
iShares MSCI BRIC Index (BKF)12.45%
iShares MSCI Italy Capped (EWI)10.97%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)8.39%
Artisan Global Equity (ARTHX)7.79%
[Benchmark] Vanguard 500 Index (VFINX)5.71%
Vanguard European ETF (VGK)5.63%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)4.86%
Homestead Value (HOVLX)4.85%
Vanguard Europe Pacific ETF (VEA)4.75%
Vanguard Value (VTV)4.71%
Vanguard Telecom Services ETF (VOX)1.14%
Vanguard Utilities (VPU)-3.13%
Proshares Ultrashort Russel2000 (TWM)-5.11%
Gold Short (DZZ)-5.97%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-5.98%
iShares Mortgage REIT (REM)-6.86%
PowerShares DB Crude Oil Dble Short (DTO)-13.01%
Proshares Ultrashort NASDAQ Biotech (BIS)-13.42%
Bond Funds1mo %
SPDR Barclays Intl. Treasury (BWX)2.92%
Artisan High Income Fund (ARTFX)1.19%
Vanguard Mortgage-Backed Securities (VMBS)-0.92%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.10%
Vanguard Long-Term Bond Index ETF (BLV)-1.86%
Vanguard Extended Duration Treasury (EDV)-3.34%

December 2017 Performance Review

January 6, 2018

In 2017 the Powerfund Portfolios gained 13% and 12.1% in our Conservative and Aggressive portfolios respectively.

It must have been a hot year in the markets because these were underwhelming returns, not considering downside. Vanguard Star Fund Vanguard Star Fund (VGSTX) was up a whopping 18.33% in 2017, the best showing in our total portfolio benchmark since a 24.85% big-crash-rebound return in 2009. This fund has more in stocks than our portfolios, and of course no shorts.

In general, a 50/50 portfolio of S&P 500 and bond-focused index funds would have been up 12.56% because the Vanguard bond index fund was up 3.46% for the year while the 500 Index fund climbed 21.67%. If you owned both of our portfolios you would have earned about this return, though perversely our more conservative account did better. The real question is, do we beat these benchmarks in the inevitable down market that's sure to follow?

As Warren Buffett said, you don't know who is swimming naked until the tide goes out. In all likelihood we're under a 50/50 stock/bond downside risk level as we're just 30% in stocks in our Conservative account in real money terms today (the rest being 61% bonds, 6% Mortgage REITs, and 2.6% short); our Aggressive portfolio is now about 54% stocks, 39% bonds and 7% leveraged short (and less stocks and more shorts in real money terms at the beginning of the year). That means that we were up 13% in an account with just 30% stocks…not too bad.

It was a hard year to lose money in 2017. Most riskier fund categories gained double digits. The weakest areas were U.S. smaller-cap value, up just 8.56%, and energy stocks, down just shy of 5%. Telecom gained just over 7%.

The hottest areas (besides cryptocurrencies) were Indian stocks, up 46%, and China which gained 41%. We captured most of this with our holding iShares MSCI BRIC Index iShares MSCI BRIC Index (BKF) up 41.81% for the year — our best position. Almost all foreign markets beat the U.S. as our dollar slid in 2017.

In December our Conservative portfolio gained 0.33% and the Aggressive portfolio gained 0.12%. Benchmark Vanguard funds for December 2017 were as follows: Vanguard 500 Index Fund (VFINX) up 1.10%; Vanguard Total Bond Market Index Fund (VBMFX) up 0.44%; Vanguard Developed Markets Index Fund (VTMGX) up 1.68%; Vanguard Emerging Markets Stock Index (VEIEX) up 3.49%; Vanguard Star Fund Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.09%.

For the month of December our foreign and value stocks were the benchmark beaters with Homestead Value (HOVLX) up 1.91%, iShares MSCI BRIC Index iShares MSCI BRIC Index (BKF) up 1.83%, and Vanguard Value (VTV) up 1.65%. Besides shorting, the losses we saw in December were in utilities and Italy, with Vanguard Utilities (VPU) down 5.88% for the month and iShares MSCI Italy Capped (EWI) down 1.3% (though Italy had a great year with a 28.7% return compared to utilities 12.5%).

In debt, longer-term bonds did well with Vanguard Extended Duration Treasury (EDV) up 2.16% and Vanguard Long-Term Bond Index ETF Vanguard Long-Term Bond Index ETF (BLV) up 1.55%. In general, longer-term investment grade as well as high risk bonds are doing well, with shorter-term investment grade debt a so-so area as shorter-term interest rates climb. Vanguard Long-Term Bond Index ETF Vanguard Long-Term Bond Index ETF (BLV) was up 10.74% for the year compared to 3.46% for the bond index most investors measure success by. In general, we had good stock and bond picks relative to the indexes and certainly relative to other fund choices; our drag was shorting and just not enough stocks.

Going forward we'll likely shift more towards the dividend-oriented areas that have had a rough time lately (those rough times caused largely by investors getting too focused on stock dividends as the end-all-be-all in the middle of the 2000s after getting pummeled in growth stocks). Now growth is back and value funds should beat tech funds again — though the valuation gap isn't nearly as great as it was in 2000. Foreign markets are no longer the relative bargain they were in early 2017.

We're watching for the Federal Reserve to push up short-term rates too far in anticipation of an economic boost from tax cuts that have driven much of the excitement in the markets recently. The boost the economy gets from lower taxes without significantly lower spending is financed by government borrowing. If the Federal Reserve raises rates because of fears of an overheated economy from tax cuts during a period of good growth and low unemployment we get even more government borrowing because the government must pay these higher interest rates on new debt. Go too far and we get a recession, no economic growth, just lots of new government debt. In general, we're well positioned for market turbulence yet continue to capture a decent chunk of the upside.

Stock Funds1mo %
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)3.49%
iShares Mortgage REIT (REM)2.20%
Homestead Value (HOVLX)1.91%
iShares MSCI BRIC Index (BKF)1.83%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.68%
Vanguard Value (VTV)1.65%
Vanguard Europe Pacific ETF (VEA)1.64%
Vanguard European ETF (VGK)1.53%
[Benchmark] Vanguard 500 Index (VFINX)1.10%
Artisan Global Equity (ARTHX)0.98%
Vanguard Telecom Services ETF (VOX)0.64%
Proshares Ultrashort Russel2000 (TWM)0.63%
iShares MSCI Italy Capped (EWI)-1.30%
Proshares Ultrashort NASDAQ Biotech (BIS)-3.16%
Gold Short (DZZ)-4.63%
Vanguard Utilities (VPU)-5.88%
ETRACS 1xMonthly Short Alerian MLP (MLPS)-7.61%
PowerShares DB Crude Oil Dble Short (DTO)-9.18%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)2.16%
Vanguard Long-Term Bond Index ETF (BLV)1.55%
Artisan High Income Fund (ARTFX)0.72%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.44%
SPDR Barclays Intl. Treasury (BWX)0.25%
Vanguard Mortgage-Backed Securities (VMBS)-0.01%