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Trade Alert

April 7, 2020

We executed trades in both portfolios on April 3 (just over one month after our previous trades on February 28th) to cut way back on corporate bonds and deal with the cash from a liquidated inverse 3x oil ETF that the fund company shut down on March 27. This ETF returned around 90% since our buy at the end of February and at least offset huge losses in our inverse gold miners ETF (which declined significantly even though gold mining stocks were down in March). So wild were the oil swings in March that at one point when the Dow was in freefall on March 19, we were up about 379% from our buy, which did briefly offer a performance offset to our declining stock funds.

Right now, corporate bonds have far more downside than upside. If we're going to take double-digit decline risk, we want more upside. While it is possible that the Fed can make this debt problem go away (or at least get lucky if we can reopen the economy sooner rather than later), there is also a chance of either serious corporate defaults or inflation resulting from distributing trillions to everyone in desperate need yet allowing production to drop. More demand, less supply is not a good mix.

The safe move with bonds is inflation-adjustable government debt or Treasury Inflation Protected Securities (TIPS). In general, we don't like this innovation because the government invented these bonds to save the treasury money, not to reward investors. Bond investors have historically required an irrational premium to own regular government debt because of the risk of inflation, a hangover from the 1970s. As we have said for years, there is not much risk of inflation above 2%, and your real danger is deflation, like in the Great Depression.

This is why regular government bonds have beat TIPS for years. That said, TIPS won't get stung much if we get depression-grade deflation from these levels (they don't pay a negative inflation adjustment, although they should). They have already underperformed as inflation expectations (correctly) have come down in this crisis, as they did in 2008. We still have some significant credit risk with our recently added emerging market bonds in case we walk away from this crisis—and the returns should be better than U.S. corporate debt in that situation.

The bulk of the trades are getting out of bond funds and into two TIPS ETFs: Vanguard Short-Term Infl-Prot Secs ETF (VTIP) and Schwab US TIPS ETF (SCHP). We are also adding a pharmaceutical ETF, mostly because they have underperformed for years and should do well in a coronavirus-slowed economy, and generally won't have trouble making debt payments (though many drug companies have lots of debt). There are some risks the government could crack down on pricing.

In our Conservative portfolio, we are adding iShares Edge MSCI USA Quality Factor ETF (QUAL), which hasn't done any better than the S&P 500 but in theory may be positioned to benefit as riskier competitors fail and are acquired by stronger players, sort of like what happened in banking in 2009. That said, these types of ETFs that try to screen for success—so-called smart beta funds—are generally bad ideas compared to the S&P 500. We also added tiny Franklin FTSE South Korea ETF (FLKR) in our continued effort to shift to countries that seem to be managing the crisis better or have more financial resources available to stimulate the economy. Somebody is going to come back online fully and fill orders, and it isn't looking like that will be us, for a variety of reasons.

In summary, we are increasing our stock risk (as we typically do during big drops), yet decreasing some of our bond credit and duration risk, and shifting more to foreign stocks that could recover faster.

March 2020 Performance Review

April 7, 2020

Ouch. The outlook for the global economy darkened amid the temporary (but not temporary enough) shutdown. Stocks tanked everywhere. At one point, the Dow was down almost 40% since the highs of mid-February, and all the gains since Trump's inauguration were destroyed. When the immense size and scale of the bailout took shape, the market took off—at one point going up around 20% from the Dow low, creating (in theory) a new bull market. Even with the rebound, as of the end of March, the S&P 500 was down around 20% for the year.

Our Conservative portfolio declined 10.98%, and our Aggressive portfolio declined 14.47%. Benchmark Vanguard funds for March 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 12.36%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.59%; Vanguard Developed Markets Index Fund (VTMGX), down 15.52%; Vanguard Emerging Markets Stock Index (VEIEX), down 17.52%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 9.75%.

Nobody knows how long the economy will be shut down. The prognosis for reopening looks grim. If the virus numbers get worse, we'll stay shut down. If they plateau, it will look like more shutdown is needed; if they go down, it will look like the shutdown is working and should be maintained. Even if the numbers fall, reopening the economy seems like a recipe for the number of cases to climb again. There is no apparent path to a functioning economy before the bills are way past due.

Unfortunately, the global economy has morphed into a highly leveraged machine—sort of like owning stocks on margin. You can get better growth as low interest rates help finance growth, but you can't slow down, because the debt payments will become impossible to make with falling revenues.

It is a bad sign that Warren Buffett just sold some of his airline shares after recently buying more a few weeks before. In theory, he should be deploying his truckloads of cash to consider taking over a viable travel-related company that just needs cash to get through the mess. He seemed more optimistic in the 2008 housing crash.

At this stage, our own portfolio changes haven't helped. While we are still down less than the stock market in 2020 (about 56% of the drop for the Conservative portfolio and ~85% for the Aggressive portfolio), last month wasn't very impressive. Our shorts didn't work out as a group, largely because 3x inverse funds don't work in the short run (or the long run for that matter) if there is a sharp reversal, even when our call was correct. In March oil, the Nasdaq and gold mining company shares were all down. Unfortunately, we lost money in two out of the three short funds here. We don't like 3x funds, but the 1x funds don't get enough trading volume or assets to use because day traders prefer the 3x leverage.

Surprisingly, our Conservative portfolio was hit hard. With no shorts in this lower-risk portfolio, bonds and safer stock funds would have had to do risk reduction, and didn't. Only VANGUARD SHORT-TERM BOND (BSV) was up slightly, while our other bond funds had too much credit risk for this market. Value funds did worse than the S&P 500; energy was clobbered, with VANGUARD ENERGY (VDE) down 36% for the month; and foreign funds generally declined more than the S&P 500.

Bonds more or less stopped offsetting downside in stocks with gains, which we have discussed as a risk in recent months as rates plunged to near zero. We should have kept the government bond funds one more month, though at one point in March, they were down significantly before the Fed engineered a bond market bailout. Worse, riskier debt not backed by the government was hit hard.

This wasn't just junk bonds and other higher-risk corporate debt, but short-term investment-grade bonds. You will see this most severely in VANGUARD SHORT-TERM CORP. BOND (VCSH), which was down 3.48% for the month. VANGUARD SHORT-TERM BOND (BSV) owns mostly government debt (which was up) along with corporate debt, and did relatively well. These performance figures for the month don't capture the mid-month slide that took these and many similar funds down 10% or more. This short-term corporate bond fund without the government debt — which only yields just under 3% — slid just over 13% in a few days in the early part of the month as investors panic-sold bonds. This was particularly bad in bond ETFs, which quite frankly are a bad idea in bad times. The underlying value of the fund assets didn't even fall by more than 10%, and if you owned the same portfolio in a traditional open-end fund format, this slide in shorter term bonds was not as severe—it was a market price issue more than an underlying bond price issue. We should have known better, as for maybe a decade , we've been harping about how there's too much money in short-term bond funds.

By our own research, this panic almost took out some municipal money market funds, sort of like in 2008 when a large money market fund "broke the buck," or the $1 price, because of losses on Lehman debt in the portfolio.

Before this panic completely took over, the Federal Reserve stepped in and hired one of the largest asset managers to basically support bond prices, including ETF shares directly. It worked. So far. Ignoring the issue that the government is creating money in the trillions and giving it to Wall Street to shore up their own bond and ETF businesses from disaster, this is not really sustainable in the long run. Corporate and municipal bond prices should be lower: there is heightened risk of default with limited revenues coming in due to the shutdown. We are pretending this will all go away soon—and it may. But it may not, and that means lots of investment-grade debt is not really investment-grade anymore. It's good for the Fed to stop a panic, but not to artificially overvalue distressed assets.

Riskier bonds had a bad month, with an 11.95% slide in our newly added iSHARES JP MORGAN EM BOND (LEMB). That was to be expected in a terrible month for risky assets in general. More of a surprise was the 7.91% slide in Dodge & Cox Global Bond Fund (DODLX), which like many bond funds has been taking on a little too much risk in the bond market to boost yield.

The basic trouble with our end-of-February trade was that there was a little too much risk, given the (in hindsight) early stage of this global market crisis. That said, somewhere between here and 50% down in the market, expect to see these portfolios move up in risk and, in the Aggressive portfolio, closer to 100% stocks, as we did in 2008—09.

Stock Funds1mo %
PROSHARES ULTRAPRO 3X SHORT OIL (OILD)89.46%
FRANKLIN FTSE CHINA (FLCH)-7.27%
[Benchmark] Vanguard 500 Index (VFINX)-12.36%
HOMESTEAD VALUE (HOVLX)-14.28%
VANGUARD FTSE DEVELOPED MARKETS (VEA)-15.19%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-15.52%
ISHARES MSCI BRIC (BKF)-15.53%
VANGUARD VALUE (VTV)-15.58%
VANGUARD FTSE EUROPE (VGK)-16.72%
PROSHARES ULTRAPRO SHORT QQQ (SQQQ)-16.84%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-17.52%
FRANKLIN FTSE GERMANY (FLGR)-18.05%
VANGUARD SMALL-CAP ETF (VBR)-25.02%
VANGUARD ENERGY (VDE)-36.39%
DIREXION GOLD MINERS BEAR 3X (JDST)-79.67%
Bond Funds1mo %
VANGUARD MORTGAGE-BACKED SECURITIES (VMBS)1.32%
VANGUARD SHORT-TERM BOND (BSV)0.45%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.59%
VANGUARD LONG-TERM BOND (BLV)-1.94%
VANGUARD SHORT-TERM CORP. BOND (VCSH)-3.48%
SPDR BLOMBERG INTL TR BOND (BWX)-3.76%
DODGE & COX GLOBAL BOND (DODLX)-7.91%
iSHARES JP MORGAN EM BOND (LEMB)-11.95%

February Performance Review

March 5, 2020

It is starting to look as if the next Black Swan for the economy and stocks is the new coronavirus making its way around the world. In February the stock market behaved like in the 2007—09 financial crisis. The 10% drop from the peak was about the fastest on record for stocks. As we have been running our portfolios on the low risk side for quite some time, going into this mini-crash we performed relatively well.

Our Conservative portfolio declined 1.78%. Our Aggressive portfolio declined 3.03%. Benchmark Vanguard funds for February 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 8.24%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.71%; Vanguard Developed Markets Index Fund (VTMGX), down 7.56%; Vanguard Emerging Markets Stock Index (VEIEX), down 3.71%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.80%.

The most startling action was actually in bonds. The decline in interest rates that started in late 2018 rapidly accelerated, leaving the U.S. with 10-year government bond yields at around 1%. We've previously discussed the possibility of our bond market heading to European and Japanese interest rate levels. These regions have long had rates of zero percent and below because of low economic growth, among other issues.

This 'How low can you go?' possibility was one reason we continued to own long-term investment grade bond funds. This helped our portfolios to avoid much of the downside last month, but it is now necessary to find alternative options. The upside from these bond funds is now limited, as is their offsetting protection against further stock losses. On the last day of the month we carried out a fairly extensive trade, largely to achieve two goals: to reduce our exposure to longer term bonds, and to shift more of our portfolio abroad — even to China.

You will no longer see them in the performance tables for the month, as we sold them at the end of the month, but the February returns were pretty high for our doom and gloom holdings that we sold: Vanguard Extended Duration Treasury (EDV) up 8.24%, Proshares Ultrashort Russel2000 (TWM) up 17.68%, and PowerShares DB Crude Oil Dble Short (DTO) up 25.61%. The losers of the month include Vanguard Utilities (VPU) down 9.99%, Vanguard Telecom Services ETF (VOX) down 5.63%, iShares MSCI Italy Capped (EWI) down 5.35%, Proshares Ultrashort NASDAQ Biotech (BIS) weirdly down 2.33%, as biotech had seemed like a solution to the outbreak, and Gold Short (DZZ) down 1.4%. These are not our exact returns as we sold these positions during the day on February 28.

This still leaves us with plenty of room to increase our stock allocation if this turns into a 2008 grade event with a 20—50% slide in stocks and a recession. The question remains: why would that be caused by a health event that to date has caused fewer deaths than die from cigarettes in China every day, and far fewer than the number of ordinary flu-related deaths per season? This is where we get into Black Swan territory — the unforeseen event that triggers major problems everywhere.

We are still at a point where all this could cease to be an issue, and the economic disruptions only create stock-buying opportunities — one more 'buy on the dip' moment. But the potential for Covid-19 to trigger something bigger is real. The main problem — which we have discussed before — is that our country is not positioned well to fight a sudden recession. We already have low interest rates, tax cuts, and government spending far in excess of tax revenue. We are in stimulus mode now. It is also not clear how more tax cuts and rate cuts would help.

On March 3 the Fed made an emergency interest rate cut of 0.50% and the market still tanked. It probably didn't help that the President said it was not enough, as so much of this is a matter of confidence. The issue this virus-related economic slowdown event creates is similar to how, when real estate prices started to decline, it exposed how risky real estate loans had become — there was no room for price declines.

Today there are many corporate borrowers who probably couldn't handle a major disruption to their business and still continue to make debt payments. This includes many commodity-related companies, such as popular master limited partnerships (MLPs) that transport energy products (which we used to short until the fund was liquidated for lack of interest). We could see a radical drop in energy consumption, beyond that experienced in the last recession. There are also companies that will be unable to obtain materials with which to make goods to sell. Much of the travel and leisure industry is facing lower volumes than in a recession, if this problem doesn't go away soon. Then there are the unknown liabilities that insurance companies may have; not so much in life insurance, but in business interruption insurance which may or may not include contagion coverage.

The best hope right now is that before businesses start missing debt payments, travel can resume, either because some sort of vaccine appears, or it turns out that the mortality rate for most people is low enough for it to seem flu-like. Until the risk of being quarantined or having your flights canceled is gone, there will be significant economic fallout globally. It would also be nice if we waived all the tariffs added against China and other countries in recent years, at least temporarily. Don't hold your breath.a.php?ticker=DZZ&pg=d">

Stock Funds1mo %
ISHARES MSCI BRIC ETF (BKF)-1.81%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.71%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-7.56%
VANGUARD FTSE DEVELOPED MARKET (VEA)-7.65%
VANGUARD FTSE EUROPE ETF (VGK)-7.96%
[Benchmark] Vanguard 500 Index (VFINX)-8.24%
HOMESTEAD VALUE FD (HOVLX)-9.38%
VANGUARD CRSP US LARGE CAP VAL (VTV)-9.71%
Bond Funds1mo %
VANGUARD LONG TERM BOND ETF (BLV)3.49%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.71%
VANGUARD MORTG-BACK SEC ETF (VMBS)0.89%
SPDR SERIES TRUST BLOMBERG INTL TR (BWX)0.03%
DODGE & COX FUNDS GLOBAL BOND (DODLX)-0.80%

Trade Alert

March 3, 2020

We made some changes to both our model portfolios on Friday 2/28/20. And while there where quite a few trades, the overall risk level from the stock bond mix hasn’t really changed significantly, more so we changed the types of stocks and bonds we wanted to be in going forward in light of some recent swings. As it turned out though, it’s a pity we didn’t increase the stock allocation much because as of Monday the stock market has been staging an amazing rebound (or dead cat bounce… only time will tell!). But then it’s typical that the highest point gain ever should come after the fastest 10% drop from a peak. Tuesday is showing markets back in the red as an emergency rate cut isn’t working. It’s that kind of a market now…

For the record, before and after this trade we are taking significantly less risk than the stock market. In February the Vanguard S&P 500 fund was down about 8.25% while our model portfolios where down about 3.1% for Aggressive and 1.8% for Conservative

As you probably noticed, stocks took a pounding and fell very fast and hard in the last week of February, largely because of growing fears that the Coronavirus outbreak will drag the global economy down significantly. This fear has also brought U.S. interest rates down to European levels, which we noted as a possible situation several times in the past and a reason to stay in longer term bonds at the time. 

In theory, a virus that still has caused fewer deaths globally than cigarettes cause every day in China shouldn’t have that much of a stock market impact. So even if there is a brief economic slowdown, it shouldn’t have much of an impact on earnings at companies over the next ten years, which is really the sort of timespan you should be looking at when you buy a stock. Much deferred spending today often just becomes future spending. It’s worth remembering that past similar viruses did not lead to major stock market events; even the 1918 Spanish flu, which killed perhaps as many as 50 million people globally, was almost a non-event as far as stocks were concerned or at least it’s impact was hard to separate from other economic issues at the time, like World War I. 

The reason this contagion may be different though is because today 1) stocks are expensive, and 2) we don’t have lots of room to fix economic problems. China now being a much bigger player in the global economy than it was during past health scares originating out of China is also a big factor to take into account.

We’ve discussed these issues of valuation and the lack of recession-busting options recently, but to sum it up: expensive stocks require good times ahead. This was the essence of the 2000 crash as the actual economy didn’t live up to the high prices of stocks at the time. 

Perhaps more troubling today, we’ve already got in place our tax cuts and low interest rates and government spending – the sort of mix that is typically used to give the economy a boost during a recession. Essentially, we’re deficit spending in a boom. So what are we going to do in the next recession? Go from a $1 trillion dollar deficit to a $3 trillion dollar deficit and cut rates to a negative 0.50%? 

There is also the issue of possible hidden problems lurking in the global economy that a sharp economic contraction will expose, even if briefly. Many people around the world today are not going about their ordinary business for fears of catching the virus. Much of this probably has more to do with the fear of being quarantined more than a worry about an actual mortality risk – because let’s face it, if you are young and healthy and can go to Italy for half off and with fewer tourists about that would be an appealing tradeoff for some, but not if there is the wild card of the risk of being quarantined for weeks in some makeshift camp. But now that flights are being cancelled for months into the future, even the virus brave are grounded.

There’s also likely to be a real drop in demand for commodities, like energy, and possibly a much sharper drop than in an ordinary recession and one that could leave heavy-in-debt energy-related companies scrambling to make debt payments. 

Ultimately the fear of a real 2008-style crash rests not just on high valuations but on rising debt defaults too, much like how falling home prices were the trigger to cascading defaults in what turned out to be a world of very shoddy real estate loans. And the concern is that some of these big corporate borrowers probably can’t handle a few months of sharply lower revenues. 

However, our trades here are not only because of the Coronacrash—several of these positions were already on the docket to be sold and we’ve noted the issues in past articles. The main reason was actually the sharp drop in rates related to the Coronacrash in stocks.

The benchmark 10-year government bond is now barely above 1%, down from around 3.16% in late 2018 before this long drop in rates started. We’ve now officially joined the European bond market, which should go hand in hand with low economic growth. While the relative value of stocks in such an environment is high, high priced stocks are not appealing in a slow growth economy. Nobody wants 50% downside just to upgrade from a 1% yield. Not in the short term at least.

More troubling to our portfolios is that we have relied on bond funds—notably long-term bond funds investing primarily in safe government debt—to lower the risk of our portfolios. Whenever stocks got rocky, we could almost bank on bonds doing well and vice versa. However, this relationship is nearing the end because ultimately we probably won’t go to negative interest rates in the U.S., simply because we borrow too much money for it to happen. If the Fed starts printing money to buy more bonds, it could happen, which is part of the problem in Europe.

The main thing we are doing here is cutting back on longer term bonds and shifting to investments abroad. We need some sort of bet to lower the risk of more stock losses and any foreign asset should do the trick, even though globally stocks have been going down as a group lately and in general they tend to move together. The reason is our dollar should slide as our rates ‘go European’ and our economy weakens. A 1,000 point drop in the Dow is going to hurt foreign stocks too, but over time if our dollar falls and valuations get closer there could be a major performance gap between here and abroad.

This could of course all represent an amazing buy-on-the-dip opportunity fueled by the temporarily low rates. But then being in long-term bonds only to see them slide sharply as rates go back to say 2% is not fun either. To be clear, we are taking on more default risk by adding say emerging market bonds and high-yield energy stocks and selling longer term U.S. debt, but hopefully this will not actually increase our downside significantly from here. If such a sharp slide continues, we may even trade again and increase our overall stock allocation. It is also entirely possible we could go in to recession mode with a 20%–40% slide and we’ll then be back to the high stock allocations we had in early 2009.

Aggressive Portfolio Trades

ISHARES JP MORGAN EM LOCAL CCY BD (LEMB)

New Bond Fund Holding – 12%

This one is risky as emerging market economies may have trouble with debt in a global crisis but the high yields and benefit of a falling U.S. dollar should help. The alternative is safer foreign bonds (like in our holding BWX, which we are reducing), but lower default risk foreign bonds typically yield nothing. 

VANGUARD SMALL-CAP VALUE ETF (VBR)

New Stock Fund Holding – 10%

After years of large cap growth outperformance, it is time for the market to swing back to favoring small cap value—an area we haven’t focused on here since the early 2000s. We used to own Vanguard Growth ETF—a large cap growth fund—and more recently had a small cap short position, which unfortunately wouldn’t work well for this purpose long haul, but the valuation call of preferring large cap growth years ago was right then. This fund is up only 4.52% annualized over the last 5 years compared to VUG Vanguard Growth, which is up 12.2% annualized. Now larger cap growth is overpriced, like in 1999, but with multiple trillion dollar large cap names, it is no wonder.

SPDR BLMBG BARCLAYS INTL TRS BD ETF (BWX)

Reduced Allocation Bond Fund – 20% to 10%

This fund actually has done well considering so many of the bonds have a negative yield. Basically, it is a play on the U.S. dollar falling and/or rates falling even more, but we’d rather achieve this in higher risk-and-return emerging market bonds given the recent drop in rates. 

VANGUARD ENERGY ETF (VDE)

New Stock Fund Holding – 8%

We’ve been anti-commodity for more than a decade and have been shorting them off and on for about that long. Owning commodities was popular a decade plus ago and has turned out a disaster for investors. While we likely won’t ever own commodities directly as they are never a good idea for investors, energy companies have gotten so cheap in this recent slide after a decade plus of bad performance, it should work out even if we just collect the 5%+ dividends—nothing to sneeze at in a 1% world. There is risk here as many smaller energy companies are leveraged and oil demand will likely tank with this virus threat (as noted in our other trade commentary), but companies like ExxonMobil which have raised dividends every year for almost four decades should be a safe bet, even if we actually get some dividend cuts. Many will simply borrow to pay the dividend at low rates. 

VANGUARD SHORT-TERM CORPORATE BOND (VCSH)

New Bond Fund Holding – 6%

This is not going to be a long-term holding and the yield is low today and also there is still some credit risk in a slowing economy. Another negative is the ongoing popularity of short-term bonds. We fully expect to sell this one for something else in the next year or so, but we’re trying to cut back on longer term bonds after the big run. 

FRANKLIN FTSE GERMANY ETF (FLGR)

New Stock Fund Holding – 6%

Germany is not growing fast and is facing a possible slowly dying manufacturing economy and has lost much ground to high-flying tech-focused America and low-cost China. That said, the yields are high and the valuations relatively low and the government is currently running a balanced budget and may consider—more than any other country—significant fiscal stimulus (actual spending) because, frankly, the negative interest rates aren’t doing much to help. The reality is, if we were running a balanced budget our own economy would be almost as sluggish. Franklin has very low-fee single-country ETFs, but the trading volume is so low they are not popular like the higher fee bigger alternatives from iShares. Hopefully, this lack of interest will change and these funds won’t get closed as is the risk with low-asset-level ETFs that are not profitable to manage.

FRANKLIN FTSE CHINA ETF (FLCH)

New Stock Fund Holding – 6%

This may be our biggest head scratcher. Why go into China now—ground zero of the virus and already hit by a trade war? However, while the short term can go poorly, China is still growing fast relative to other countries and its stock market has been in a decade-long doldrums coming off the stock bubble of the mid-2000s. There is also more potential for new government spending than in other major economies, like ours. Often the least popular move works out the best. Franklin has very low-fee single-country ETFs, but the trading volume is so low they are not popular like the higher fee alternatives, often from iShares. Hopefully, this lack of interest will change and these funds won’t get closed as is the risk with low-asset-level ETFs.

VANGUARD LONG-TERM BOND ETF (BLV)

Allocation Change – 20% to 6%

As noted, this fund is invested in long-term bonds and has benefited significantly from the slide in rates over the years, especially the drop that started in 2018. This fund is up 9% this year, 19% last year. The ten-year return is 8.25% annualized. That is stock-like with less risk, but now the risk is going up and the likely returns down. One reason long-term bonds have done so well is that so few owned them relative to shorter term bonds. Everybody was piled up in short-term bonds waiting for the big move up in rates that never happened. We fully expect to be able to go back to this fund or something similar when rates move up even to say 2% on the ten-year bond. In fact, we are still keeping an allocation here.

DIREXION DAILY JR GLD MNRS BEAR 3X (JDST)

New Inverse Fund Holding – 3%

This recent gold run-up will likely subside if we get more deflation from an economic slowdown or if the economy heats back up with low rates. There is also the situation that gold is still used in jewelry and that demand will drop in a global recession. The bull case is just more expectations of inflation that never come to being, but gold bugs don’t tend to care about bad long-term performance. We need to get out of DZZ—our gold bullion short—because the fund is too small and not well supported by the fund family (they won’t even return our calls!). This fund shorts with even more leverage than actual mining companies and could have real trouble in an economic slowdown, even if gold doesn’t fall sharply. 

PROSHARES ULTRAPRO SHORT QQQ (SQQQ)

New Inverse Fund Holding – 3%

We’re out of small cap shorting because the most overpriced part of the global market is larger cap tech stocks. That said, without a real market slide, this fund could down almost 100% over time, which is why it is only a very small allocation. If the market tanks, this fund will be sold and shifted to stocks for the eventual rebound. Frankly, it would be better to just short the actual QQQ ETF and even more frankly, if we could earn 3% again on longer term government bonds, we would just do that, but there are few good ways to reduce portfolio downside today.

PROSHARES ULTRAPRO 3X SHRT CRUDE OI (OILD)

New Inverse Fund Holding – 2%

Unlike almost all our other shorts, shorting commodities works even with these ill-conceived daily leveraged inverse funds. Our favorite was PIMCO CommoditiesPLUS Short Strategy Fund,  but PIMCO closed it on us right around when it would have become a great investment. Our longer term oil short (DTO) has almost always offered offsetting gains during stock weakness, partially because oil was often overpriced from speculation and the futures market typically priced oil more expensive in the future, giving the opportunity for a tailwind shorting. Adding to this, oil typically tanks in a recession when stocks sink. This new holding is more leveraged, unfortunately, but trades more frequently than the tiny DTO.

VANGUARD UTILITIES ETF (VPU)

Sold 7% to 0%

This fund delivered us nice low-risk returns, but utility stocks have been sucked into this obsession with low-volatility stocks and are now too popular, not because of the utility funds per se but because of the massive low-volatility ETFs. Many utility stocks are now no longer low volatility or low risk—just look at the price swings in recent days. The yields were nice in a falling rate environment, but at the end of the day these are now expensive slow-growth stocks, that may actually take an earnings hit if power demand drops in a recession or, worse, a virus outbreak. 

ISHARES MSCI ITALY CAPPED ETF (EWI)

Sold 6% to 0%

Italy just isn’t as out of favor as it was when we invested in this fund and is not the country to invest in during a slowing global economy—they just don’t have the money to do stimulus, though they are benefiting from the ultralow rates in Europe.

PROSHARES ULTRASHORT RUSSELL2000 (TWM)

Sold 3% to 0%

Several years ago small cap value stocks were overpriced compared to larger cap growth stocks, which were cheap after underperforming in the 2000s. Unfortunately, there were no small cap value inverse funds, just small caps and in general these funds don’t offer any long-term value, but they can reduce downside in a slide. Ultimately, investors are better off just avoiding overpriced areas, not shorting. Not going to sugarcoat it… these funds have hurt us. We should have just owned even more long-term bonds.

Vanguard Communication Services ETF (VOX)

Sold 3% to 0%

This fund became a mess right around when it morphed into a tech fund, which we noted and used as a reason to sell it in our other lower risk portfolio. It was a loser even with Google and Facebook stakes and is now a risky fund for a market crash, unlike before, which is why it needs to go.

PROSHARES ULTRASHORT NASDAQ BIOTECH (BIS)

Sold 3% to 0%

Biotech stocks are still overpriced, even though they have slightly underperformed the S&P 500 with more risk. That said, this inverse fund won’t help in the long run or the short term as biotech may seem appealing to investors during coronavirus-type outbreaks. 

DB CRUDE OIL DOUBLE SHORT ETN (DTO)

Sold 3% to 0%

The fact that this leveraged short fund has had a positive return since it launched in 2008 is amazing given the almost-certain negative returns of any leveraged inverse fund over time. The fact that it tends to skyrocket in price when stocks fall is another plus (it was recently up over 40% YTD). That said, the wind at its back has been generally higher oil prices in the future than the current (spot) market, making shorting futures slightly profitable with no change in the oil price. This phenomenon isn’t as good as it has been, but in truth, the main reasons we are trading this fund for another oil short are illiquidity and fund size.  

DB GOLD DOUBLE SHORT ETN (DZZ)

Sold 6% to 0%

Gold and silver are still bad investments, although for some reason millions of people haven’t noticed despite the prices still being below the levels they hit in 2011 (significantly below in silver’s case) while stocks have more than doubled. You still see gold coin ads everywhere (often sham collectable coins). That said, this fund doesn’t trade enough to use and is basically not supported by the fund family (they won’t call us back!), so we are switching to a more actively traded short on gold-mining stocks.

Conservative Portfolio Trades

VANGUARD SHORT-TERM BOND ETF (BSV)

New Bond Fund Holding – 15%

This is probably not going to be a long-term holding, the yield is low, and there is still some credit risk in a slowing economy (though less than our new corporate short-term fund). Another negative is the ongoing popularity of short-term bonds. We fully expect to sell this holding for something else in the next year or so but we’re trying to cut back on longer term bonds after the big run. 

VANGUARD FTSE EUROPE ETF (VGK)

Allocation Change – 8% to 12%

Europe is cheaper than the U.S. now and when you adjust for our deficit spending boosting our GDP, it’s not growing that much slower. There is more room for fiscal stimulus, especially in Germany. They also don’t have the worry of increasing socialism—they already have it! The dividend yield is higher and there could be a return boost if our dollar sinks, which might happen after years of riding high.

VANGUARD ENERGY ETF (VDE)

New Stock Fund Holding – 10%

FRANKLIN FTSE GERMANY ETF (FLGR)

New Stock Fund Holding – 7%

ISHARES JP MORGAN EM LOCAL CCY BD (LEMB)

New Bond Fund Holding – 7%

VANGUARD LONG-TERM BOND ETF (BLV)

Allocation Change – 19% to 6%

VANGUARD MORTGAGE-BACKED SECS ETF (VMBS)

Allocation Change – 12% to 6%

In theory, we could hang on to this fund as mortgages haven’t declined in perfect lockstep with treasury bond rates, but at the same time, they are still not offering much yield as well as little benefit from further rate cuts. The expected return is so low from here though that we’d rather add a little risk and reward, plus we just added a short-term bond fund which doesn’t yield that much less.

VANGUARD UTILITIES ETF (VPU)

Sold – 6% to 0%

ISHARES TRUST GLOBAL COMM SERVICES ETF (IXP)

Sold – 13% to 0%

Shortly after (VOX) became essentially a tech fund, this ETF did the same. It was mediocre even with Google and Facebook stakes and is now a risky fund for a market crash, unlike before when it was more of a telecom utility fund, which is why it needs to go now.

VANGUARD EXTENDED DUR ETF (EDV)

Sold – 5% to 0%

This fund has been a long-time staple here and remains underowned (though much larger than when we bought it). This low-fee fund owns zero coupon bonds, which are essentially default-risk free, but with the most interest rate risk possible in the bond world, even slight changes in long-term rates can lead to wild swings in this fund. This fund is actually slightly more volatile than the S&P 500. However, it tends to take off when stocks fall and has been a great hedge against stock market risk—better over time than any shorting strategy. The fund was up over 18% last year and so far in 2020. The ten-year return is 11.65%, compared to 12.90% for the S&P 500 ETF (SPY). That said, with a 1% ten-year government bond, the downside is higher than the upside by far, even though interest rates will probably not break 3% on the ten year for years to come. We will be back in this fund if rates climb significantly. It is possible this fund will do another 20%+ as rates go closer to zero, but 90%+ of the money has already been made here. At the end of the day, bonds are not stocks and this fund can’t match the S&P 500 over the next 10 years, unless the stock market is about where it is now in a decade.

January 2020 Performance Review

February 6, 2020

The global stock and bond markets went back into recession fear mode after a great 2019. Some of this was fear of the currently spreading coronavirus. As our portfolios are fairly well positioned for an environment where investors expect an economic slowdown, we beat all the benchmarks in January. This lower risk position also explains our relative underperformance last year.

Our Conservative portfolio gained 1.75%. Our Aggressive portfolio gained 0.49%. Benchmark Vanguard fund performances in January 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 0.04%; Vanguard Total Bond Market Index Fund (VBMFX), up 2.11%; Vanguard Developed Markets Index Fund (VTMGX), down 2.76%; Vanguard Emerging Markets Stock Index (VEIEX), down 5.05%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.18%.

In general, global health scares are not a huge market event, but past contagions occurred when the stock market was less expensive, so the past may not be a good indication of the future. A more relevant factor is that China used to constitute a relatively small part of the global economy, and that is no longer the case. When the SARS coronavirus broke out in 2002, China had a 4% share of global GDP. Today, it is around 16%. Factor in the drag of the trade war, and really, anything can happen.

Oil reversed sharply during this rough month, pushing up our inverse fund PowerShares DB Crude Oil Dble Short (DTO) by 28%. Not including our short funds, our best performer was Vanguard Utilities (VPU) which delivered a particularly strong 6.77% return as interest rates were sliding and money was shifted to safer investments benefiting higher yield and generally safer utility stocks. Everything else on the stock side was either up slightly or down. International markets were particularly weak, with losses in the 3—6% range, notably in emerging markets with China exposure. Our own iShares MSCI BRIC Index (BKF) was our worst performer: down 5.19%. Oil wasn't the only weak commodity; all commodities were down, which sort of makes sense, as China is the biggest consumer of many commodities.

Bonds did well, notably the longer-term investment grade bonds we own, that tend to be where investors go in a panic. We're still worried that this party is almost over, but there could be one good move up (rates down) if and when we fall into our next recession. At the top of the list was Vanguard Extended Duration Treasury (EDV), up 10.32% for the month. Long-term government bonds were the number one fund category last month, followed by utilities, followed by long-term bonds. This largely explains our relatively good returns in January compared to the benchmarks.

In the last couple of days this scare seems to be leaving the markets faster than it appeared. This is because there is so much money in the system. Speaking of...what really got the reversal going in stocks was not news that China found a virus cure, but found a cure for the market — they basically lowered rates and injected over a hundred billion into the economy. It's the solution for all that ails you.

The more surprising event of recent days that didn't get much attention was Tesla stock doing a 1990s and going parabolic, as all the funds shorting the stock had to get out of the way . This took Tesla to a higher market cap than any other auto company in the world except Toyota, and Tesla almost passed Toyota's roughly $200 billion dollar market value to become #1 before plunging 17% in a day. For the record, Toyota has over 10 times the revenue of Tesla. This sort of exuberance by stock investors is more of a worry than the coronavirus.

Stock Funds1mo %
PowerShares DB Crude Oil Dble Short (DTO)28.16%
Proshares Ultrashort NASDAQ Biotech (BIS)12.35%
Proshares Ultrashort Russel2000 (TWM)6.77%
Vanguard Utilities (VPU)6.10%
Gold Short (DZZ)0.94%
Vanguard Telecom Services ETF (VOX)0.62%
iShares Global Telecom ETF (IXP)0.29%
[Benchmark] Vanguard 500 Index (VFINX)-0.04%
Homestead Value (HOVLX)-2.06%
iShares MSCI Italy Capped (EWI)-2.44%
Vanguard Value (VTV)-2.50%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.76%
Vanguard Europe Pacific ETF (VEA)-3.00%
Vanguard European ETF (VGK)-3.09%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-5.05%
iShares MSCI BRIC Index (BKF)-5.19%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)10.32%
Vanguard Long-Term Bond Index ETF (BLV)5.32%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.11%
Dodge & Cox Global Bond Fund (DODLX)1.08%
Vanguard Mortgage-Backed Securities (VMBS)0.66%
SPDR Barclays Intl. Treasury (BWX)0.42%

December 2019 Performance

January 8, 2020

The stock market was strong in December, particularly abroad, capping off an unexpectedly strong year overall. Low-credit-risk bonds (government-backed and safer corporate debt) were flat to down, although they also had an amazing year as last year's interest rate increases reversed course.

We did fine against our total portfolio Vanguard benchmark last month, mostly from strong performance abroad, but are essentially embarrassed to admit that our Aggressive portfolio was only up 14.98% in 2019, while our Conservative portfolio scored a more respectable 17.63%. Keep in mind the Vanguard S&P 500 Admiral (cheap) class was up about 31.46% and Vanguard STAR a solid 22.21%. We were taking quite a bit less risk than both, is all we can say that's positive about this beating.

Our Conservative portfolio gained 1.43%. Our Aggressive portfolio gained 2.05%. Benchmark Vanguard funds for December 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 3.01%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.15%; Vanguard Developed Markets Index Fund (VTMGX), up 3.49%; Vanguard Emerging Markets Stock Index (VEIEX), up 6.96%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.11%.

Our hottest funds last month were investing abroad, including iShares MSCI BRIC Index (BKF), up 8.02%; and Vanguard European ETF (VGK), up 4.51%. Much of this was the dollar drifting lower, as even our foreign bond funds such as Dodge & Cox Global Bond Fund (DODLX) and SPDR Barclays Intl. Treasury (BWX) had decent positive returns—unlike our losses in Vanguard Long-Term Bond Index ETF (BLV), down 1.04%, and Vanguard Extended Duration Treasury (EDV), down 4.55% last month. Other than in bonds, only our inverse funds had losses last month. For the year, it was very difficult for any non-tech-oriented fund in the United States to beat the S&P 500 in 2019, but it was also uncommon for a stock fund category investing anywhere in the world to come in under about a 25% return for the year.

What a difference a year makes! This time last year, a recession seemed imminent, and the stock market briefly saw a roughly 20% decline from the 2019 peak. Along the path of apparent doom, the Federal Reserve reversed course on raising interest rates. The Fed also was ever so slowly shrinking the so-called balance sheet of bonds bought with newly created money post-recession, and went back to letting sleeping dogs lie, presumably to increase this pile of money once again as soon as the economy slips up. The Fed was trying to get ahead of slowly rising inflation in the tax cut and spending—boosted economy but flipped back to recession and deflation-fighting mode.

A few rate cuts later, and investors and apparently the entire global economy were over the 2018 fear. In fact, 2019 turned out to be among the best years for the combined stock and bond markets. The only real weak areas last year were commodities and energy funds, with some specific country funds such as India in low single-digit territory. Shorter-term bonds and cash (which have huge allocations by the investing public, in the trillions) were low-return, but longer-term bonds were up well over 10% in 2019.

The bad news is that all this upside should end as big run-ups late in a bull market often do (1929, 1987, 2000)—and possibly sharply. But there is also a case for some sort of permanently high plateau, to quote an infamously bad call made in 1929 before the crash by famed economist Irving Fisher. The forever-elevated stock market basically lives off of the forever low interest rate environment, where most safe debt and cash globally has a current yield at or below inflation. You almost have to take risk. In such an environment, it will be very difficult for stocks to underperform bonds over the next 10 years: it would take deflation like Japan had. This is very different than 1999, when bonds and cash had high yields and real estate was cheap, and only stocks were overpriced.

Even the slightest shakeup in this global order—like the modest interest rate increases in 2018—and the whole house of cards seems to start coming down. Basically, few can afford higher interest rates, including the highly indebted governments globally, and real estate prices based on payments can't take another 2008-grade hit without causing major headaches all over again. This was the essence of the late 2018 mini bear market.

Other factors at play are the increasing alarming signs of excess in IPO and startup financing, which puts 1999 to shame. WeWork alone probably wasted more money than half the dot-coms of the late 1990s combined. It bought a Gulfstream private jet for about what Pets.com raised in a public stock offering shortly before collapse of the infamous sock puppet Superbowl advertiser. Predicting when the easy money available for growth will dry up is as difficult as knowing when rates will go back up again.

The main positive from these levels is that in theory, interest rates could go even lower, and we could get down around 0%—1% yields on long-term government debt, as many major economies abroad already have. This could push stocks and real estate up even more. Maybe in the future the whole concept of yield will be antiquated: everything will yield under inflation, and the only way to beat inflation will be with capital gains.

Stock Funds1mo %
iShares MSCI BRIC Index (BKF)8.02%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)6.96%
Vanguard European ETF (VGK)4.51%
Vanguard Europe Pacific ETF (VEA)3.56%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.49%
Homestead Value (HOVLX)3.39%
Vanguard Utilities (VPU)3.10%
[Benchmark] Vanguard 500 Index (VFINX)3.01%
iShares MSCI Italy Capped (EWI)2.81%
Vanguard Value (VTV)2.65%
iShares Global Telecom ETF (IXP)2.49%
Vanguard Telecom Services ETF (VOX)2.24%
Proshares Ultrashort NASDAQ Biotech (BIS)-2.26%
Gold Short (DZZ)-4.81%
Proshares Ultrashort Russel2000 (TWM)-5.65%
PowerShares DB Crude Oil Dble Short (DTO)-17.75%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)1.59%
SPDR Barclays Intl. Treasury (BWX)1.35%
Vanguard Mortgage-Backed Securities (VMBS)0.24%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.15%
Vanguard Long-Term Bond Index ETF (BLV)-1.04%
Vanguard Extended Duration Treasury (EDV)-4.55%

November 2019 Performance Review

December 6, 2019

This year is turning out to do much more for stocks than merely reversing the sharp declines of late 2018. The risk is that if corporate earnings don't continue growing at a reasonably fast pace to meet the increasingly high expectations of stock prices, the drop in the next recession is going to be that much worse.

Our Conservative portfolio gained 0.60%. Our Aggressive portfolio gained 0.26%. Benchmark Vanguard funds for November 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 3.62%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.06%; Vanguard Developed Markets Index Fund (VTMGX), up 1.40%; Vanguard Emerging Markets Stock Index (VEIEX), up 0.15%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.47%.

It wasn't a good month for our portfolio relative to benchmarks, as bonds were basically flat for the month, dragging at our bond funds. The US dollar rose a little, hurting our foreign bond funds and dragging on foreign stocks relative to the US market. We had one value fund Homestead Value (HOVLX) beat the S&P 500, while our foreign stock funds were up between zero and about half as much as the US market. Shorting anything but gold hurt our returns. Emerging markets and Italy were barely up at all. Utilities were down around 2%.

At this point, only in early 2000 was the US stock market more overpriced for stocks, creating a potential for a bigger decline than today. Yet that crash was easier to diversify out of, with much higher interest rates on cash and bonds back then, and lower valuations abroad and in smaller cap and value stocks. The next drop will probably be more like 2007—2009 with across-the-board global slides. On a more disturbing note, there will be less ammunition from the Federal Reserve and White House to fight the next big one than there was to fight the last two recessions and stock slides, as the US had ample room for debt expansion, and interest rate and tax cuts, in those past recessions.

The best case for stocks (other than a strong global economy for years to come, which is still possible) is interest rates remaining low globally and continuing to deliver negative inflation-adjusted yields for safe bonds in most countries, yet high enough inflation that stocks at least have inflatable dividend yields and earnings growth. In other words, you lose a little in bonds and gain a little in stocks.

A 10-year government bond yielding 0% in most major countries and maybe 1.75% in the US, with inflation 1—2% globally in major markets, is a dead-to-negative investment for a decade. But a stock market yielding 1.9% today, trading at 20+ times earnings, will deliver (if it ends up at the same valuation in 10 years) a slightly better-than-inflation return (with significant downside risk in a recession or valuation compression event). Even with zero dividends, the return will be an inflation-matching return with risk.

The lack of good options will keep the game afloat for years because there is too much money to invest globally — unless there is a scary event that makes a 50% loss seem possible. The real danger is not even higher inflation of, say, 3%+ but inflation going back to zero or negative, hurting stock prices in multiple ways including problems with companies making interest payments on their non-zero yield debt with flat-to-declining earnings. A similar (if not worse) phenomenon would happen in commercial and residential real estate, as rents flatten out or decline but interest is still due on the buildings with tenants. This is why deflation must always be stopped in its tracks — even if it means interest rates below inflation for even more years and decades to come

Stock Funds1mo %
Gold Short (DZZ)5.30%
Homestead Value (HOVLX)3.68%
[Benchmark] Vanguard 500 Index (VFINX)3.62%
Vanguard Value (VTV)3.44%
Vanguard Telecom Services ETF (VOX)3.19%
iShares Global Telecom ETF (IXP)2.84%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.40%
Vanguard Europe Pacific ETF (VEA)1.34%
Vanguard European ETF (VGK)1.29%
iShares MSCI BRIC Index (BKF)0.17%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.15%
iShares MSCI Italy Capped (EWI)0.07%
Vanguard Utilities (VPU)-1.98%
PowerShares DB Crude Oil Dble Short (DTO)-7.04%
Proshares Ultrashort Russel2000 (TWM)-7.71%
Proshares Ultrashort NASDAQ Biotech (BIS)-20.15%
Bond Funds1mo %
Vanguard Long-Term Bond Index ETF (BLV)0.32%
Vanguard Mortgage-Backed Securities (VMBS)0.08%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.06%
Vanguard Extended Duration Treasury (EDV)-0.08%
Dodge & Cox Global Bond Fund (DODLX)-0.09%
SPDR Barclays Intl. Treasury (BWX)-1.46%

October 2019 Performance Review

November 4, 2019

Globally, stocks continued up, with only a slight drop in longer-term bonds. It is almost like the bond market is expecting a recession soon and "better safe than sorry" but the stock market wants to play musical chairs until the actual record stops on the economy. The weakness in small cap and foreign stocks over the last year plus was nowhere to be seen, as most stocks went up last month.

Our Conservative portfolio gained 1.02%. Our Aggressive portfolio gained 1.15%. Benchmark Vanguard funds for October 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 2.15%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.21%; Vanguard Developed Markets Index Fund (VTMGX), up 3.26%; Vanguard Emerging Markets Stock Index (VEIEX), up 3.87%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.96%.

We're running out of upside on bonds as it seems interest rates may not go lower without real economic trouble. The Federal Reserve just lowered short-term interest rates for the third time since increasing them last year with a high likelihood of pausing at this level with 1.5% at the bottom of the range, and there is a growing feeling that it may work—we engineered our way out of the recession that was brewing. But like the recent tax cuts, for how long? And what is the plan now that we have low rates and high government deficit spending like you would expect in a weak economy, not a strong one. Consumers aren't scared, but business owners are a little skittish about the future.

European stocks did well, as if Europe—already in zero interest rate mode—needed US rates lower to keep their economies out of recession. iShares MSCI Italy Capped (EWI) led the pack, up 4.72% for the month, followed by Vanguard European ETF (VGK), up 3.84%. Value stocks didn't do as well as the increasingly mega cap growth and tech driven S&P 500, with Vanguard Value (VTV) up 1.9% compared to the S&P 500's 2.15%. All our shorts were down except for a barely positive return for PowerShares DB Crude Oil Dble Short (DTO).

Riskier bonds did better last month, as did foreign bonds, leading to a 1.17% return for Dodge & Cox Global Bond Fund (DODLX) and a 0.89% return for SPDR Barclays Intl. Treasury (BWX). The yield curve shape moved back slightly to a normal positive slope, thanks to the Fed lowering rates and longer-term rates inching up. Confidence returned, as an inverted yield curve was scaring investors that a recession was around the corner. Vanguard Extended Duration Treasury (EDV), basically the longest-term bond fund you can get, was down 1.42% even though the bond market index, which is mostly shorter-term bonds, was up 0.21%.

The odd thing? The unfolding impeachment news doesn't seem to be impacting the markets much. That could be because no matter how it plays out, it won't reverse the corporate tax cuts that are boosting after-tax earnings anytime soon. The political pressure might even limit Trump's trade war, which the stock market doesn't seem to like all that much, anyway.

Stock Funds1mo %
iShares MSCI Italy Capped (EWI)4.72%
iShares MSCI BRIC Index (BKF)4.70%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)3.87%
Vanguard European ETF (VGK)3.84%
Vanguard Telecom Services ETF (VOX)3.29%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.26%
Vanguard Europe Pacific ETF (VEA)3.21%
Homestead Value (HOVLX)2.86%
iShares Global Telecom ETF (IXP)2.44%
[Benchmark] Vanguard 500 Index (VFINX)2.15%
Vanguard Value (VTV)1.90%
PowerShares DB Crude Oil Dble Short (DTO)0.71%
Vanguard Utilities (VPU)-0.10%
Proshares Ultrashort Russel2000 (TWM)-4.91%
Gold Short (DZZ)-5.14%
Proshares Ultrashort NASDAQ Biotech (BIS)-13.90%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)1.17%
SPDR Barclays Intl. Treasury (BWX)0.89%
Vanguard Mortgage-Backed Securities (VMBS)0.34%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.21%
Vanguard Long-Term Bond Index ETF (BLV)-0.30%
Vanguard Extended Duration Treasury (EDV)-1.42%

September 2019 Performance Review

October 3, 2019

Economic expectations drifted back up somewhat, sending interest rates and stocks higher, but there is still significant fear the next recession is not far away. There are also percolating fears that, globally, central banks are not going to have an answer for the next downturn besides creating more money—a path that may be limited by inflation higher than experienced over much of the last decade. There just doesn't seem to be a way to get out of high levels of borrowing made by basically everyone at low rates. Even with the weak month for bonds, we had a decent month relative to benchmarks.

Our Conservative portfolio gained 0.22%. Our Aggressive portfolio rose 1.00%. Benchmark Vanguard funds for September 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 1.86%; Vanguard Total Bond Market Index Fund (VBMFX), down 0.60%; Vanguard Developed Markets Index Fund (VTMGX), up 3.09%; Vanguard Emerging Markets Stock Index (VEIEX), up 1.33%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.90%.

The fear-buying of gold this year reversed last month as interest rates climbed. Oil also drifted down, as the economy globally just isn't strong enough for high oil prices. The levels we are at now basically require political problems in oil countries, of which there are plenty to go around. Value stocks seem to be taking the lead and European stocks did well, arguably because they are basically value stocks now. Small cap is doing well. There are more than a few signs that investors have overindulged on growth stories. Money-losing startups that own $60 million dollar private planes to jet founders between their different houses as well as business opportunities are on that list. We are going to have to make some adjustments soon.

The third trouble area (after global economic weakness and concerns that central banks are running out of options) is the current political issues facing the Whitehouse. In general, an impeachment event doesn't have much significant sway in the markets' longer run (and didn't in the late 1990s), but in theory it could send the country down a path where higher taxation isn't just required for budget reasons—we are already there—but more for punishment reasons or for elevated desires to redistribute wealth more than has already been done by the progressive tax code. More of a danger to markets is what the White House will do while under heat — this recent news of tariffs against European countries comes to mind.

Undoing the recent corporate tax cut by itself would likely lead to a large adjustment to stock prices that are now priced on higher after-tax profits. This won't be a major crash, as prices probably never really went up as much as possible because, in investors' eyes, the corporate tax cut was never going to be forever in full anyway. It doesn't help that the President warns of a market crash if he doesn't get his way on the off-chance he does not.

Collectively, none of these concerns would be particularly worrisome if we weren't already at very elevated valuations in stocks, and now bonds—and probably real estate, while you are at it. There is not much room for error. Interest rates are probably going to stay low globally for a long time. So, for the time being, if the economy stays reasonably strong, we can just stay in a high valuation world. What we don't need is a reason for investors to want out.

Stock Funds1mo %
Gold Short (DZZ)7.31%
Proshares Ultrashort NASDAQ Biotech (BIS)6.09%
PowerShares DB Crude Oil Dble Short (DTO)4.42%
Vanguard Value (VTV)3.46%
Vanguard Utilities (VPU)3.30%
Vanguard Europe Pacific ETF (VEA)3.16%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.09%
Homestead Value (HOVLX)2.88%
Vanguard European ETF (VGK)2.55%
iShares MSCI Italy Capped (EWI)2.45%
[Benchmark] Vanguard 500 Index (VFINX)1.86%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.33%
iShares MSCI BRIC Index (BKF)1.05%
iShares Global Telecom ETF (IXP)0.25%
Vanguard Telecom Services ETF (VOX)-0.54%
Proshares Ultrashort Russel2000 (TWM)-4.53%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)0.54%
Vanguard Mortgage-Backed Securities (VMBS)0.13%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.60%
SPDR Barclays Intl. Treasury (BWX)-1.01%
Vanguard Long-Term Bond Index ETF (BLV)-1.94%
Vanguard Extended Duration Treasury (EDV)-4.07%

August 2019 Performance Review

September 7, 2019

Stocks gave back some of the gains made in August as economic and trade fears kept bubbling up. In this environment the bond market remained red hot as interest rates plunged yet again. This boosted our portfolios relative to benchmarks as we have been taking more interest rate risk (but less stock risk) than most other portfolios for quite a few years now. The stock market is still up around 18% for the year, including dividends, although it is up only about 2.8% over the last 12 months, as that includes the big slide late last year.

Our Conservative portfolio gained 1.93%. Our Aggressive portfolio gained 1.07%. Benchmark Vanguard funds for August 2019 were as follows: Vanguard 500 Index Fund (VFINX), down 1.59%; Vanguard Total Bond Market Index Fund (VBMFX), up 2.78%; Vanguard Developed Markets Index Fund (VTMGX), down 1.91%; Vanguard Emerging Markets Stock Index (VEIEX), down 3.76%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.56%.

The 30-year U.S. government bond recently yielded less than 2%. This is a record low but is still quite a bit higher than foreign government bonds, many of which have negative yields. This partly explains the sudden attraction to the bond market here, though this phenomenon has been in place for quite some time — years, actually. Foreign investors aren't the only ones buying bonds; fund investors here have added tens of billions of dollars to bond funds, as fears circulate that the next recession will probably lead to another 50% drop in stocks, like the last two did — fool me thrice, shame on me. The problem with this strategy is that during the last two recessions, interest rates started high and you made money in higher-grade bonds as stocks and yields declined. We're at recession level interest rates but with boom time stock prices.

This bond market action led to some wild gains in our longer-term bond funds last month, notably with the ultra-rate-sensitive zero coupon bond ETF Vanguard Extended Duration Treasury (EDV) up 15.47% and Vanguard Long-Term Bond Index ETF (BLV) up 8.24%. These are the sorts of gains we'd expect in the next recession and big bear market, not during a time of low unemployment and near record levels in stocks.

Small caps, oil, and biotech were weak last month, leading to gains in most of our short positions as well, but not in our short gold ETN, which slid nearly 14%. Gold investors seem to think this is all going to end in inflation somewhere, or maybe now they are just trying to avoid the negative interest rates common abroad.

Looking ahead, the trouble is that we are running out of yield and upside in bonds. If stocks were very weak we'd definitely be switching from bonds to stocks. But stocks by many measures are also near historically high valuations, notably total market cap to GDP. Adding to the problems, shorter-term rates are going back down, with more drops on the way as the Fed tries to keep the economy out of recession and fight the yield curve inversion. We're also running large deficits, limiting our fiscal solutions to a future economic slowdown. Want more? Inflation isn't even that low, as it was a few years ago.

Small-cap value stocks had a surprisingly bad month with a drop of over 6%, while the S&P 500 was down just 1.6%. This has been a multi-year trend, with one of the widest performance gaps ever between large-cap growth stocks and small-cap value stocks over the last few years. As we noted years ago when we took on the inverse small-cap ETF while also owning larger cap growth funds, this was something we expected, but there was no small-cap value inverse ETF (just small cap in general) and no good way to make this bet over many years, other than merely avoid smaller cap value funds. Now it is time to consider the opposite position and shift from larger cap growth funds to smaller cap value.

It was all losses in overseas stocks, with the best of the losers being in Europe and Japan, down a mere 2%+, while emerging markets were down more in the 4—8% range. The best U.S. sectors last month were precious metals (up about 4.7%), utilities (up 2.7%), and real estate (up just over 2%). Pretty much everything else was down, especially the big 10% drop in energy, a sector that is actually looking interesting now after a terrible decade (roughly since the time everybody thought energy investing was such a great idea).

Best case: it is possible we've reached some sort of permanently high plateau in bonds and stocks, where there isn't going to be much upside in either but the economy is strong enough and inflation low enough (and the amount of money looking for investments great enough) that these markets sort of stick around these levels, but with some wild swings. Of course, in 1929, a few days before the 90% slide began, a now infamous economist said the stock market had reached what looked like a permanently high plateau, and destroyed an otherwise impressive career. Just on flows of money, which wildly favor bonds (unlike in 2000), stocks should beat bonds over the next 5—10 years. This doesn't matter much because right now everybody is concerned about the next 1—2 years.

Stock Funds1mo %
Proshares Ultrashort Russel2000 (TWM)9.20%
PowerShares DB Crude Oil Dble Short (DTO)8.02%
Vanguard Utilities (VPU)4.83%
Proshares Ultrashort NASDAQ Biotech (BIS)4.49%
iShares MSCI Italy Capped (EWI)-0.44%
[Benchmark] Vanguard 500 Index (VFINX)-1.59%
Vanguard European ETF (VGK)-1.65%
Vanguard Europe Pacific ETF (VEA)-1.88%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.91%
iShares Global Telecom ETF (IXP)-2.61%
Vanguard Telecom Services ETF (VOX)-2.78%
Vanguard Value (VTV)-2.97%
Homestead Value (HOVLX)-3.60%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.76%
iShares MSCI BRIC Index (BKF)-4.00%
Gold Short (DZZ)-13.95%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)15.47%
Vanguard Long-Term Bond Index ETF (BLV)8.24%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.78%
SPDR Barclays Intl. Treasury (BWX)1.85%
Vanguard Mortgage-Backed Securities (VMBS)0.93%
Dodge & Cox Global Bond Fund (DODLX)-0.54%

July 2019 Performance Review

August 6, 2019

The U.S. market continued up in July and is back to record levels, erasing the losses of late 2018. With rising trade tensions as the catalyst and a backdrop of suspiciously low interest rates, August is looking to wipe out much of the recent gains with a roughly 800-point one-day drop in the Dow and interest rates plunging to levels last seen right before the last presidential election. We'll come back to the 800-point gorilla in the room after a review of last month.

In July, U.S. stocks did fine, while foreign stocks slipped. This, plus low positive returns in bonds, led to only slight gains in our more bond-heavy Conservative portfolio and slight losses in our more stock-heavy portfolio dragged down by foreign funds, more or less in line with the Vanguard STAR Fund, a global balanced portfolio, that we watch.

Our Conservative portfolio gained 0.63%. Our Aggressive portfolio declined 0.20%. Benchmark Vanguard funds for July 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 1.43%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.23%; Vanguard Developed Markets Index Fund (VTMGX), down 2.09%; Vanguard Emerging Markets Stock Index (VEIEX), down 1.19%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.52%.

Foreign markets are having a pretty good year but are lagging U.S. markets and were down in July. Healthcare was the main weak area in the United States, as constant talk of sticking it to the healthcare industry by both parties may be weighing on this industry, which has had years of above-market growth from increased subsidized health insurance and fast-rising prices for drugs and services. Our strongest areas in stocks last month were in value and telecom holdings, the latter boosted by new higher-technology stakes (which we are concerned about going forward from these levels).

Which brings us to the August situation. On the surface, this mini-slide started when the president re-upped his trade war tariff threats. Investors have seen many ups and downs in this often Twitter-based trade war with China, and frankly, the actual economic impact broadly speaking has been minimal. But then, the economy was strong and could shrug off minor issues. Now, with the bond market saying (through low long-term rates that are even lower than low short-term rates) that a global recession is coming soon, investors are getting nervous. We don't need a trade war with the number two economy in the world right now.

Adding relatively low tariffs to trade with one country was never really much of an economic drag for us. While there were certainly disruptions in specific industries, mostly commodities and agriculture, the consumer and most companies haven't felt much of a pinch.

This is partially explained by the fact that U.S. corporations are enjoying a major tax cut that exceeds by a wide margin the cost of tariffs they have to pay. Granted, some of the companies enjoying the most in tax breaks are not the ones paying the most in tariffs, but as a whole stock market, the tax cuts exceed the drag on earnings from tariffs. This doesn't mean that a trade war, if it doesn't achieve much, is a good idea, just that it shouldn't have to cause a recession.

But if you look at the history of sizable stock market slides, rarely was the trigger such a momentous economic event to warrant trillions in market value damage. In the last couple of decades, we had a crash from the Thai currency collapsing and from a default on old Soviet debt. Greece debt issues, which haven't even really gone away, once caused a major stir.

When you have jittery investors who have just seen fast gains over the previous years, you have an environment for a slide. Plus, we don't know what one relatively minor event leads to, because as Warren Buffett said, you don't know who is swimming naked until the tide goes out. For the record, Warren Buffett is sitting on a record amount of cash, probably waiting for the tide to go out so he can get some bargains.

Therefore, the real danger of a trade war with China is if we win, so to say. Most of the stuff coming in from China is really our brands anyway—we've basically set up factories or otherwise outsourced manufacturing to an efficient, low-cost, and low-regulation factory town. When was the last time you purchased an actual Chinese brand as opposed to just something made in China?

When we have a trade gap with China, it is because Apple makes phones in China and ships them here for sale. If the factory was in Texas (not going to happen, Apple just moved their last computer production from the United States to China), there would be a much smaller trade gap with China and a much higher price for phones and computers.

Through this lens, clearly we are paying the tariff. If the tariff threat ever does go up to include iPhones, either Apple is going to pay and eat the cost to keep the consumer price where it is or it is going to pass the cost on to the consumer. It could actually benefit Apple, because their leading competitor in higher-end phones, Samsung, makes their top-of-the-line phone in China. Apple has more money to subsidize tariffs. Maybe they'll have to pause their stock buyback program for a while.

How China pays is where the real economic trouble could happen. U.S. companies may cut down on demand from China. Walmart or, increasingly, Amazon may need less made-in-China items. If Apple doesn't eat the tariff and the price goes up, consumers may wait to buy a phone. All of this means that the suppliers in China temporarily lay off workers and stop buying from other suppliers. It could cause a recession—in China. Since China is a very leveraged high-growth country, this could cause unforeseen problems. Tesla is building a $2 billion factory near Shanghai. Without demand by the Chinese for these pricy cars, Tesla could default on debt.

It is worth noting that the manufacturing cost of most finished goods is a very small part of the retail price, so a 10% or even 25% increase in costs means a $100 sneaker may cost $1 more to manufacture. This isn't going to lead to much disruption to our consumers or our companies.

The latest shock to the market was when the Chinese currency declined in value, which we claim is currency manipulation, though it is exactly what you would expect if we bought less stuff in China and converted fewer dollars to Chinese currency.

On the plus side, interest rates are going so low so fast as to cause some sort of boost to an already pretty strong economy. This could all go away almost as fast as it has appeared. It really depends if people and companies go out and borrow more. Which will return us to the high-asset-price leveraged country that somehow can't handle even 2.5% short-term rates and not much higher long-term rates—which is what caused the short bear market last year in the first place.

Stock Funds1mo %
Proshares Ultrashort NASDAQ Biotech (BIS)6.59%
Vanguard Telecom Services ETF (VOX)3.43%
iShares Global Telecom ETF (IXP)2.50%
Homestead Value (HOVLX)2.17%
Vanguard Value (VTV)1.46%
[Benchmark] Vanguard 500 Index (VFINX)1.43%
PowerShares DB Crude Oil Dble Short (DTO)0.64%
Vanguard Utilities (VPU)-0.21%
Proshares Ultrashort Russel2000 (TWM)-0.79%
Gold Short (DZZ)-0.80%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.19%
iShares MSCI BRIC Index (BKF)-1.74%
iShares MSCI Italy Capped (EWI)-1.89%
Vanguard Europe Pacific ETF (VEA)-2.04%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.09%
Vanguard European ETF (VGK)-2.60%
Bond Funds1mo %
Dodge & Cox Global Bond Fund (DODLX)1.09%
Vanguard Long-Term Bond Index ETF (BLV)0.51%
Vanguard Mortgage-Backed Securities (VMBS)0.44%
Vanguard Extended Duration Treasury (EDV)0.44%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.23%
SPDR Barclays Intl. Treasury (BWX)-1.29%

June 2019 Performance Review

July 4, 2019

The stock market continues to rebound from all the traumatic events of the past year or so. Strangely, this is not due to particularly strong expectations for growth globally; it appears to be mostly related to interest rates declining in anticipation of an economic slowdown. The rate decline pushed up bond prices again, keeping us more or less in the ballpark of more stock-heavy (and risky) portfolios.

Our Conservative portfolio gained 3.17%. Our Aggressive portfolio gained 3.49%. The results for benchmark Vanguard funds for June 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 7.03%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.15%; Vanguard Developed Markets Index Fund (VTMGX), up 5.93%; Vanguard Emerging Markets Stock Index (VEIEX), up 5.42%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 5.07%.

While there are continued fears over the trade war leading to gyrations in stock prices, the real risk is whether we get a global economic slowdown — which, if it happens, probably won't be because of a relatively small trade war of a few billion dollars a year in taxes, a sum eclipsed by the tax cuts we have already received.

The stock market doesn't seem to think a real economic slowdown is in the cards as it makes record highs, but the bond market says a recession is likely — it is like two different economies.

Stock market investors are hoping that the low interest rates caused by fear of a global slowdown will lead to the economy avoiding a recession from the boosting of low rates. In addition, the expectation is now that the Federal Reserve will lower rates soon to fight the slowdown, and it will work maybe a little too well. Basically, investors are hoping the economy looks worse than it actually is and that low rates will juice the economy, just like the tax cuts and increased spending did last year. This may not be as crazy as it sounds, given we're even considering cutting rates to boost an economy with a 3.6% unemployment rate — and the short-term rates the Fed controls directly never broke 2.5% on the way up, which is less than half the level of before the 2008 recession.

None of this addresses how we will buy ourselves out of a serious recession, if one appears. We have government power split dysfunction again, and have already lowered taxes and increased spending — a de facto stimulus plan. All the Fed can do is lower short-term rates by a couple of percentage points, after which we have little available in turbo boost except more money creation to buy our own debt.

We will probably need to create money to buy our debt because our yearly deficit will quickly skyrocket above $1 trillion. It is already going to be around $900 billion for this fiscal year, and that's in good times. In 2009 the deficit about tripled to $1.4T from the previous year. Next time around we may have to raise taxes in a recession to keep the deficit under $2T. Or try Modern Monetary Theory, or MMT, the hipster central bank strategy of just printing money to pay for stuff. Apparently that is a question for another day, because record stock market closes continue…

Our only S&P-beating stock fund performer in June was iShares MSCI Italy Capped (EWI), up 9.72% as a rising euro and receding fears of politically oriented economic problems boosted prices. Yield-oriented funds such as Vanguard Telecom Services ETF (VOX), Vanguard Utilities (VPU), and iShares Global Telecom ETF (IXP) were our weakest non-short funds, with gains between roughly 3% and 4%. This was a month when the S&P 500 beat almost all fund categories, except in a few strong areas such as Latin America and Precious Metals. Our longer-term and foreign bonds did well compared to the bond index with a 3.43% return for SPDR Barclays Intl. Treasury (BWX), a 2.79% return for Dodge & Cox Global Bond Fund (DODLX) and a 2.69% return for Vanguard Long-Term Bond Index ETF (BLV).

Stock Funds1mo %
iShares MSCI Italy Capped (EWI)9.72%
[Benchmark] Vanguard 500 Index (VFINX)7.03%
Vanguard Value (VTV)6.44%
Vanguard European ETF (VGK)6.31%
iShares MSCI BRIC Index (BKF)6.03%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.93%
Vanguard Europe Pacific ETF (VEA)5.83%
Homestead Value (HOVLX)5.59%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)5.42%
iShares Global Telecom ETF (IXP)4.07%
Vanguard Telecom Services ETF (VOX)3.94%
Vanguard Utilities (VPU)3.35%
Proshares Ultrashort Russel2000 (TWM)-12.98%
Gold Short (DZZ)-15.04%
PowerShares DB Crude Oil Dble Short (DTO)-17.01%
Proshares Ultrashort NASDAQ Biotech (BIS)-17.04%
Bond Funds1mo %
SPDR Barclays Intl. Treasury (BWX)3.43%
Dodge & Cox Global Bond Fund (DODLX)2.79%
Vanguard Long-Term Bond Index ETF (BLV)2.69%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.15%
Vanguard Extended Duration Treasury (EDV)0.75%
Vanguard Mortgage-Backed Securities (VMBS)0.68%